UNITED
      STATES


SECURITIES
      AND EXCHANGE COMMISSION


WASHINGTON,
      D.C. 20549




**F
      O R M 20 – F**





o
            REGISTRATION
                STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE
                ACT
                OF 1934


OR


x
            ANNUAL
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934


For
      the
      fiscal year ended December 31, 2007


OR


o
            TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934


OR


o
            SHELL
                COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
                EXCHANGE
                ACT OF 1934





Date
      of
      event requiring this shell company report________________





For
      the
      transition period from ________ to ________





Commission
      file number: 005-52583





**BLUEPHOENIX
      SOLUTIONS LTD.**


(Exact
      Name of Registrant as Specified in Its Charter)





**Israel**


(Jurisdiction
      of Incorporation or Organization)





**8
      Maskit Street, Herzliya 46733, Israel**


(Address
      of Principal Executive Offices)





**Varda
      Sagiv, CFO, 8 Maskit Street, Herzliya 46733, Israel**


**Tel:
      972 9 9526110, Fax: 972 9 952611**


(Name,
      Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)


_________________





Securities
      registered or to be registered pursuant to Section 12(b) of the
      Act:





Title
                of Each Class
            
            Name
                of Each Exchange on Which RegisteredOrdinary
                shares, NIS 0.01 par value
            
            NASDAQ
                Global Market





Securities
      registered or to be registered pursuant to Section 12(g) of the
      Act:


None


(Title
      of
      Class)





Securities
      for which there is a reporting obligation pursuant to Section 15(d) of the
      Act:


Ordinary
      shares, NIS 0.01 par value


(Title
      of
      Class)









Indicate
      the number of outstanding shares of each of the issuer’s classes of capital or
      common stock as of December 31, 2007:


20,626,627
      Ordinary shares, NIS 0.01 per share





Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act.





Yes
o 
No
x








If
      this
      report is an annual or transition report, indicate by check mark if the
      registrant is not required to file reports pursuant to Section 13 or 15(d)
      of
      the Securities Exchange Act of 1934.





Yes
o 
No
x








Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      preceding 12 months (or for such shorter period that the registrant was required
      to file such reports), and (2) has been subject to such filing requirements
      for
      the past 90 days.




Yes
x 
No
o





Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer. See definition of “accelerated
      filer” in Rule 12b-2 of the Exchange Act. (Check one):





Large
      accelerated filer o   Accelerated
      filer x    Non-accelerated
      filer o





Indicate
      by check mark which basis of accounting the registrant has used to prepare
      the
      financial statements included in this filing:


U.S.
      GAAP
x





International
      Financial Reporting Standards as issued by the International Accounting
      Standards Board o





Other
      o





Indicate
      by check mark which financial statement item the registrant has elected to
      follow.





Item
      17
o    Item 18 x





If
      “Other” has been checked in response to the previous question, indicate by check
      mark which financial statement item the registrant has elected to
      follow.


Item
      17
o   Item 18 o





If
      this
      is an annual report, indicate by check mark whether the registrant is a shell
      company (as defined in Rule 12b-2 of the Exchange Act).





Yes
oNo
x







**TABLE
      OF CONTENTS**




P
                A
                R T I
            1ITEM
                1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT, AND ADVISERS
            2ITEM
                2. OFFER STATISTICS AND EXPECTED TIMETABLE
            2ITEM
                3. KEY INFORMATION
            2A.
            Selected
                Financial Data
            2B.
            Capitalization
                and Indebtedness
            3C.
            Reasons
                for the Offer and Use of Proceeds
            3D.
            Risk
                Factors
            4ITEM
                4. INFORMATION ON THE COMPANY
            17A.
            History
                and Development of the Company-
            17B.
            Business
                Overview
            17C.
            Organizational
                Structure
            34D.
            Property,
                Plants and Equipment
            35ITEM
                4A. UNRESOLVED STAFF COMMENTS
            36ITEM
                5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
            36A.
            Operating
                Results
            44B.
            Liquidity
                and Capital Resources
            50C.
            Research
                and Development, Patents and Licenses
            55D.
            Trend
                Information
            55E.
            Off-Balance
                Sheet Arrangements
            55F.
            Tabular
                Disclosure of Contractual Obligations
            55G.
            Safe
                Harbor
            56ITEM
                6. DIRECTORS, SENIOR MANAGEMENT, AND EMPLOYEES
            56A.
            Directors
                and Senior Management
            56B.
            Compensation
            59C.
            Board
                Practices
            60D.
            Employees
            67E.
            Share
                Ownership
            68ITEM
                7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
            71A.
            Major
                Shareholders
            71B.
            Related
                Party Transactions
            72C.
            Interests
                of Expert and Counsel
            74ITEM
                8. FINANCIAL INFORMATION
            75A.
            Consolidated
                Statements and Other Financial Information
            75B.
            Significant
                Changes
            75ITEM
                9. THE OFFER AND LISTING
            76A.
            Offer
                and Listing Details
            76B.
            Plan
                of Distribution
            78C.
            Markets
            78D.
            Selling
                Shareholders
            78E.
            Dilution
            78F.
            Expenses
                of the Issue
            78ITEM
                10. ADDITIONAL INFORMATION
            79A.
            Share
                Capital
            79B.
            Memorandum
                and Articles of Association
            79C.
            Material
                Contracts
            82D.
            Exchange
                Controls
            82E.
            Taxation
            83F.
            Dividend
                and Paying Agents
            90G.
            Statement
                by Experts
            90H.
            Documents
                on Display
            91I.
            Subsidiary
                Information
            91




ii




ITEM
                11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
                RISK
            91ITEM
                12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
            91P
                A
                R T II
            92ITEM
                13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
            92ITEM
                14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND
                USE OF
                PROCEEDS
            92ITEM
                15. CONTROLS AND PROCEDURES
            92ITEM
                16A. AUDIT COMMITTEE FINANCIAL EXPERT
            93ITEM
                16B. CODE OF ETHICS
            93ITEM
                16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
            93ITEM
                16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT
                COMMITTEES
            94ITEM
                16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED
                PURCHASERS
            94P
                A
                R T III
            95ITEM
                17. FINANCIAL STATEMENTS
            95ITEM
                18. FINANCIAL STATEMENTS
            95ITEM
                19. EXHIBITS
            95




iii




**P
      A R T I**




*Some
      of the statements in this annual report, including those in the Risk Factors,
      Operating and Financial Review and Prospects, and Business Overview sections,
      are forward-looking statements that involve risks and uncertainties. These
      forward-looking statements include statements about our plans, objectives,
      strategies, expectations, intentions, future financial performance, and other
      statements that are not historical facts. We use words like “anticipates,”
“believes,” “expects,” “future,” “intends,” and similar expressions to mean that
      the statement is forward-looking. You should not unduly rely on these
      forward-looking statements, which apply only as of the date of this annual
      report. Our actual results could differ materially from those anticipated in
      the
      forward-looking statements for many reasons, including the risks described
      under
      Risk Factors.*





*As
      used in this annual report, references to “we,” “our,” “ours,” and “us” refer to
      BluePhoenix Solutions Ltd. and its subsidiaries, unless otherwise indicated.
      References to “BluePhoenix” refer to BluePhoenix Solutions
      Ltd.*





*The
      name BluePhoenixTM and the names BluePhoenixTM IT Discovery, BluePhoenixTM
LogicMiner, BluePhoenixTM DBMSMigrator, BluePhoenixTM PlatformMigrator,
      BluePhoenixTM Rehosting, BluePhoenixTM LanguageMigrator, BluePhoenixTM
DataMigrator, BluePhoenixTM* *SOA-Ready Enablement* *(Formerly known as WS4Legacy,) BluePhoenixTM* *FieldEnabler* *,
      BluePhoenixTM* *StandardsEnabler* *,
      BluePhoenixTM* *COBOL/LE-Enabler* *,*  *BluePhoenixTM
      EuroEnabler, BluePhoenixTM Refactoring Repository (Nebula- code name),
      BluePhoenixTM AppBuilder, BluePhoenixTM* *Redevelopment,*  *ASNA
      Monarch TM, ASNA Visual RPG® (AVR) and ASNA DataGate®* *appearing
      in this annual report are trademarks of our company. Other trademarks in this
      annual report are owned by their respective holders.* ****




1




**ITEM
      1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT, AND ADVISERS**





Not
      applicable.




**ITEM
      2. OFFER STATISTICS AND EXPECTED TIMETABLE**




Not
      applicable.




**ITEM
      3. KEY INFORMATION**




**A.**  **Selected
      Financial Data**





The
      following tables present our consolidated statement of operations and balance
      sheet data for the periods and as of the dates indicated. We derived the
      statement of operations data for each of the years ended December 31, 2005,
      2006 and 2007 and the balance sheet data as of December 31, 2006 and 2007 from
      our consolidated financial statements included in Item 18 of this annual report,
      which have been prepared in accordance with generally accepted accounting
      principles as applied in the United States, or U.S. GAAP. Our consolidated
      financial statements have been audited by **** Ziv
      Haft,
      independent registered public accounting firm, BDO member firm. The selected
      consolidated financial data as of December 31, 2003, 2004 and 2005 and for
      the
      years ended December 31, 2003 and 2004 is derived from our audited
      financial statements not included in this annual report, which have been
      prepared in accordance with U.S. GAAP. You should read the selected consolidated
      financial data set forth below together with our consolidated financial
      statements included elsewhere in this annual report. See “Item 5. Operating and
      Financial Review and Prospects.”




2


**Year
                    Ended December 31,****2007**
                
                **2006**
                
                **2005**
                
                **2004**
                
                **2003**$**Consolidated
                    Statements of Operations Data:**
                
                **(in
                    thousands, except per share data)**Revenues
                
                $
                88,398
                
                $
                68,004
                
                $
                58,947
                
                $
                57,186
                
                $
                54,340Cost
                    of revenues
                
                
                38,661
                
                
                28,515
                
                
                25,379
                
                
                24,253
                
                
                24,115Gross
                    profit
                
                
                49,737
                
                
                39,489
                
                
                33,568
                
                
                32,933
                
                
                30,225Research
                    and development costs
                
                
                14,109
                
                
                9,400
                
                
                8,006
                
                
                8,055
                
                
                8,138Selling,
                    general, and administrative expenses
                
                
                32,820
                
                
                22,149
                
                
                21,611
                
                
                21,388
                
                
                20,140Goodwill
                    impairment
                
                
                6,989
                
                
                -
                
                
                -
                
                
                -
                
                
                -Restructuring
                    costs
                
                
                694
                
                
                -
                
                
                -
                
                
                -
                
                
                -Total
                    operating expenses
                
                
                54,612
                
                
                31,549
                
                
                29,617
                
                
                29,443
                
                
                28,278Operating
                    income (loss)
                
                
                (4,875
                )
                
                7,940
                
                
                3,951
                
                
                3,490
                
                
                1,947Financial
                    income (expenses), net
                
                
                (4,373
                )
                
                (3,515
                )
                
                (1,978
                )
                
                (882
                )
                
                165Gain
                    on realization of shareholdings
                
                
                -
                
                
                -
                
                
                -
                
                
                112
                
                
                376Other
                    income, net
                
                
                892
                
                
                282
                
                
                104
                
                
                975
                
                
                567Income
                    (loss) before taxes on income
                
                
                (8,326
                )
                
                4,707
                
                
                2,077
                
                
                3,695
                
                
                3,055Income
                    tax expense (income)
                
                
                68
                
                
                (282
                )
                
                149
                
                
                260
                
                
                152(8,394
                )
                
                4,989
                
                
                1,928
                
                
                3,435
                
                
                2,903Equity
                    in earnings (losses) of affiliated companies, net
                
                
                35
                
                
                -
                
                
                -
                
                
                (516
                )
                
                (898
                )Minority
                    interest
                
                
                163
                
                
                (317
                )
                
                (139
                )
                
                (73
                )
                
                (154
                )Net
                    income (loss)
                
                $
                (8,196
                )
                $
                4,672
                
                $
                1,789
                
                $
                2,846
                
                $
                1,851Basic
                    earning (loss) per share
                
                $
                (0.48
                )
                $
                0.34
                
                $
                0.13
                
                $
                0.21
                
                $
                0.14Diluted
                    earnings (loss) per share
                
                $
                (0.48
                )
                $
                0.33
                
                $
                0.13
                
                $
                0.21
                
                $
                0.14Weighted
                    average number of shares outstanding
                
                
                17,145
                
                
                13,889
                
                
                13,557
                
                
                13,523
                
                
                13,451Weighted
                    average number of shares outstanding assuming dilution
                
                
                17,145
                
                
                14,371
                
                
                13,973
                
                
                14,679
                
                
                13,644


**December
                  31,****2007**
              
              **2006**
              
              **2005**
              
              **2004**
              
              **2003****$****Consolidated
                  Balance Sheet Data:**
              
              (in
                  thousands)Working
                  capital
              
              $
              25,299
              
              $
              17,861
              
              $
              4,546
              
              $
              6,357
              
              $
              246Total
                  assets
              
              
              146,858
              
              
              127,466
              
              
              99,691
              
              
              90,882
              
              
              80,820Total
                  liabilities
              
              
              29,965
              
              
              62,169
              
              
              42,894
              
              
              37,381
              
              
              30,732Shareholders’
                  equity
              
              
              111,708
              
              
              59,949
              
              
              51,766
              
              
              48,631
              
              
              45,398




**B.**  **Capitalization
      and Indebtedness**





Not
      applicable.




**C.**  **Reasons
      for the Offer and Use of Proceeds**





Not
      applicable.




3




**D.**  **Risk
      Factors**





Our
      business, financial condition, and results of operations could be materially
      adversely affected by any of the following risks. Additional risks and
      uncertainties that we are not aware of or that we currently believe are
      immaterial may also adversely affect our business, financial condition, results
      of operations and our liquidity. The trading price of our ordinary shares could
      decline due to any of these risks, and you may lose all or part of your
      investment.




**Risks
      Related to Our Business**




***If
      capital spending on information technology, or IT, slows down, our business
      could be seriously harmed.***




Economic
      changes such as the U.S. subprime mortgage loan crisis and the economic
      instability caused by the rise in oil prices, are affecting companies’
willingness, in both the U.S. and in Europe, to make capital spending on IT
      projects. In addition, many of our customers are in the financial sector. A
      slow-down in the financial markets may affect these customers’ willingness to
      make capital spending on IT projects. We cannot know whether IT capital spending
      and investment in IT projects will continue in the future at the same level,
      or
      how the economic conditions will affect our business. Accordingly, we cannot
      assure you that we will be able to increase our revenues or keep our revenues
      at
      the same level as in 2007.




***Our
      acquisition of existing businesses and our failure to successfully integrate
      these businesses could disrupt our business, dilute your holdings in us, and
      harm our financial condition and operating results.***




From
      2004
      through 2007, we acquired and increased our investment in several businesses.
      We
      intend to make future strategic acquisitions of complementary companies,
      products, or technologies. Such acquisitions could disrupt our business. In
      addition, your holdings in our company would be diluted if we issue equity
      securities in connection with any acquisition, as we did in the acquisitions
      of
      BridgeQuest Inc., and the activity of CodeStream Software Ltd., referred to
      as
      CodeStream.




Acquisitions
      involve numerous risks, including:




· problems
      combining the acquired operations, technologies, or products;


· unanticipated
      costs or liabilities;


· diversion
      of management’s attention;


· adverse
      effects on existing business relationships with suppliers and
      customers;


· risks
      associated with entering markets in which we have no or limited prior
      experience; and


· potential
      loss of key employees, particularly those of the acquired
      organizations.




4




Further,
      products that we acquire from third parties often require significant
      expenditures of time and resources to upgrade and integrate with our existing
      product suite. We may not be able to successfully integrate any business,
      technologies, or personnel that we have acquired or that we might acquire in
      the
      future, and this could harm our financial condition and operating
      results.




***If
      we fail to manage our growth effectively, our business could be disrupted,
      which
      could harm our operating results.***




Our
      current expansion places a strain on our senior management team and other
      resources, such as our management information systems and operating,
      administrative, financial, and accounting systems. We are undergoing rapid
      growth in the number of our employees, the size and locations of our physical
      facilities, and the scope of our operations, due, in part, to several
      acquisitions we have made. Any failure to manage our growth effectively could
      disrupt our business and harm operating results.




***If
      we are unable to accurately predict and respond to market developments or
      demands, our business will be adversely affected.***




The
      IT
      modernization business is characterized by rapidly evolving technology and
      methodologies. This makes it difficult to predict demand and market acceptance
      for our modernization tools and services. In order to succeed, we need to adapt
      the tools and services we offer to keep up with technological developments
      and
      changes in customer needs. We cannot guarantee that we will succeed in enhancing
      our tools and services, or developing or acquiring new modernization tools
      and
      services that adequately address changing technologies and customer
      requirements. We also cannot assure you that the tools and services we offer
      will be accepted by customers. If our tools and services are not accepted by
      customers, our future revenues and profitability will be adversely affected.
      Changes in technologies, industry standards, the regulatory environment,
      customer requirements, and new product introductions by existing or future
      competitors could render our existing solutions obsolete and unmarketable,
      or
      require us to enhance our current tools or develop new tools. This may require
      us to expend significant amounts of money, time, and other resources to meet
      the
      demand. This could strain our personnel and financial resources.




***We
      may experience significant fluctuations in our annual and quarterly results,
      which makes it difficult to make reliable period-to-period comparisons and
      may
      contribute to volatility in the market price of our ordinary
      shares.***




Our
      quarterly and annual results of operations have fluctuated significantly in
      the
      past, and we expect them to continue to fluctuate significantly in the future.
      These fluctuations are the result of risks related to the introduction of new
      products and any of the following events:




· adverse
      economic conditions in various geographic areas where our customers and
      potential customers operate;


· acquisitions
      and dispositions of companies;


· timing
      of
      completion of specified milestones and delays in implementation;


· timing
      of
      product releases;


· timing
      of
      contracts;


· increases
      in selling and marketing expenses, as well as other operating expenses;
      and


· currency
      fluctuations and financial expenses related to our financial
      instruments.




5





In
      addition, unexpected events that do not occur on a regular basis and that are
      difficult to predict may cause fluctuations in our operating results. For
      example, based on the impairment tests performed by us in the fourth quarter
      of
      2007, an impairment loss of $7 million related to goodwill has been identified
      in Mainsoft, a company in which we have held 58% of the outstanding shares
      since
      2001. As a result, we recorded a one-time, non-cash, charge of $7 million as
      impairment of goodwill and had a net loss of $8.2 million in 2007 compared
      to
      net income of $4.7 million generated in 2006 and $1.8 million in 2005.




As
      a
      result of the foregoing, we believe that period-to-period comparisons of our
      historical results of operations are not necessarily meaningful and that you
      should not rely on them as an indication for future performance. Also, it is
      possible that our quarterly and annual results of operations may be below the
      expectations of public market analysts and investors.




***A
      delay in collecting our fees could result in cash flow shortages, which in
      turn
      may significantly impact our financial results.***




Typical
      modernization projects which deploy our solutions are long-term projects.
      Therefore, payment for these projects or a substantial portion of our fees
      may
      be delayed until the successful completion of specified milestones. In addition,
      the payment of our fees is dependent upon customer acceptance of the completed
      work and our ability to collect the fees. Further, although the timing of
      receipt of our fees varies, we incur the majority of our expenses on a current
      basis. As a result, a delay in the collection of our fees could result in cash
      flow shortages. Any significant variation in estimated and actual revenues
      obtained may significantly impact our financial results in any given
      period.




***Our
      subsidiary, Mainsoft Corporation, is dependent on Linux open-source technology,
      which could have a material adverse effect on our
      business.***




The
      Mainsoft for Java EE product line has been developed using a subset of the
      Linux
      operating system, the open-source Mono project led by Novell. The open-source
      Mono project is an open-source implementation of the Microsoft .NET framework
      and is included in multiple Linux distributions. Microsoft may claim that the
      open-source Mono project infringes certain Microsoft patents. In addition,
      Microsoft may prevent access to the Visual Studio Integration Partner (VSIP)
      program to companies using the open-source Mono project. VSIP is a program
      designed for independent software vendors, and other third parties interested
      in
      integrating tools, components, and languages into the Microsoft Visual Studio.
      This may result in severe damage to Mainsoft’s ability to effectively market the
      Mainsoft for Java EE product line. These developments could have a material
      adverse effect on our financial condition, and results of operations.




***Our
      subsidiary, Mainsoft Corporation, is dependent on its alliance with
      IBM.***




Mainsoft
      currently invests a lot of efforts in marketing its product through its
      strategic alliance with IBM. However, there is no assurance that this strategic
      alliance will continue or produce the expected growth. At this stage, Mainsoft
      is expected to increase its revenues, but incur losses.




6




***If
      we fail to address the strain on our resources caused by changes in our product
      offerings, we will be unable to effectively manage our
      business.***




In
      the
      past few years, we have undergone significant changes in our product offerings.
      These changes included acquiring new technologies, developing and marketing
      new
      modernization and migration tools, and expanding the sales of our products
      further into international markets. This has placed and will continue to place
      substantial demands upon our management, systems, and resources, including
      our
      sales, project management, consulting personnel, and research and development
      operations. Our ability to manage any future changes or growth depends on our
      ability to continue to implement and improve our operational, financial, and
      management information control and reporting systems on a timely basis, and
      to
      expand, train, motivate, and manage our work force. If we cannot respond
      effectively to changing business conditions, our business, financial condition,
      and results of operations could be materially adversely affected.




***If
      we are unable to invest in new products and markets or to manage the effects
      of
      changes in our offering portfolio, our results will be adversely
      affected.***




We
      specialize in the development and implementation of sophisticated software
      modernization and porting tools and products. We leverage our know-how,
      experience, and generic technologies to develop and introduce new software
      tools
      that enable the modernization of legacy systems. The need for our modernization
      solutions changes over time, and recent regulations or newly introduced
      technologies may create new needs for modernization solutions. As part of our
      growth strategy, as new needs evolve, we typically conduct a market analysis
      to
      qualify and quantify the market opportunity. If the results justify the
      investment required for the development of new products or tools, then we begin
      the development process of the new product. In order to maintain our position
      in
      the market, and our ability to address the constantly changing needs of the
      marketplace, we continually invest in the development of new products. The
      gross
      annual expense related to research and development was $17.7 million in 2006
      and
      $19.4 million in 2007.




In
      order
      to properly introduce a new product to the marketplace or to introduce our
      current products into new markets, we continuously update our marketing
      materials, educate our sales force, and make changes to our operations. If
      these
      activities are not completed in a timely or satisfactory manner, our new product
      introduction may be delayed and our business, financial condition, and results
      of operations could be materially adversely affected.




***Our
      future results could be adversely affected by an impairment of the value of
      certain intangible assets.***




The
      assets listed in our consolidated balance sheet include, among other things,
      goodwill valued at approximately $54 million, capitalized research and
      development costs valued at approximately $32 million and intangible assets
      related to customers’ relations valued at approximately $2.6 million. The
      applicable accounting standards require that (a) goodwill
      is not amortized, but rather is subject to an annual impairment test. We perform
      an annually impairment test, or more frequently if impairment indicators are
      present. Intangible assets that are not considered to have an indefinite useful
      life are amortized using the straight-line basis over their estimated useful
      lives. The carrying amount of these assets is reviewed whenever events or
      changes in circumstances indicate that the carrying value of an asset may not
      be
      recoverable. Recoverability of these assets is measured by comparison of the
      carrying amount of the asset to the future undiscounted cash flows the assets
      is
      expected to generate. If the asset is considered to be impaired, the amount
      of
      any impairment is measured as the difference between the carrying value and
      the
      fair value (usually discounted cash flow) of the impaired asset ;
      and (b)
      acquired technology and development  costs
      of
      software that is intended for sale that were incurred after the establishment
      of
      technological feasibility of the relevant product, be capitalized and tested
      for
      impairment on a regular basis, and written down when capitalized costs exceed
      its net realizable value.




7




Pursuant
      to impairment tests performed in the fourth quarter of 2007, an impairment
      loss
      of $7 million related to goodwill in Mainsoft has been identified and was
      charged to income. In January 2008, we announced management’s decision to sell
      our holdings in Mainsoft. The remaining goodwill identified to Mainsoft amounts
      to $4 million. There can be no assurance that future goodwill impairment tests
      or the consideration that will result from the intended sale of Mainsoft, if
      it
      occurs, will not result in additional charges to earnings. If our goodwill
      or
      capitalized research and development costs were deemed to be impaired in whole
      or in part due to our failure to achieve our goals, or if we fail to accurately
      predict the useful life of the capitalized research and development costs,
      we
      could be required to reduce or write off such assets, thus adversely affecting
      our operating results.




***If
      we are unable to attract, train, and retain qualified personnel for our
      worldwide facilities at competitive prices, we may not be able to achieve our
      objectives and our business could be harmed.***




In
      order
      to achieve our objectives, we hire from time to time additional software,
      administrative, operational, sales, and technical support personnel. The process
      of attracting, training, and successfully integrating qualified personnel can
      be
      lengthy and expensive. We may not be able to compete effectively for the
      personnel we need. As part of our growth strategy, we developed offshore centers
      in Cyprus, Romania, India and St. Petersburg (Russia). We hired professional
      consultants for these development centers, leveraging the lower employer costs
      that existed in these countries. Recently, professional work in these countries
      became more expensive and professional fees may continue to increase in the
      future. The establishment of additional offshore facilities may result in
      significant capital expenses, which may affect our cash position. We cannot
      assure you that our offshore facilities will be profitable. Our future success
      depends on our ability to absorb and retain senior employees and to attract,
      motivate, and retain highly qualified professional employees worldwide at
      competitive prices.




***If
      we fail to estimate accurately the costs of fixed-price contracts, we may incur
      losses.***




We
      derive
      a portion of our revenues from engagements on a fixed-price basis. We price
      these commitments upon estimates of future costs. We bear the risk of faulty
      estimates and cost overruns in connection with these commitments. Our failure
      to
      accurately estimate the resources required for a fixed-price project, to
      accurately anticipate potential wage increases, or to complete our contractual
      obligations in a manner consistent with the project plan could materially
      adversely affect our business, operating results, and financial condition.
      In
      addition, we may agree to a price before the design specifications are
      finalized, which could result in a fixed price that is too low, resulting in
      lower margins or losses to us.




8




***If
      our tools or solutions do not function efficiently, we may incur additional
      expenses.***




In
      the
      course of providing our modernization solutions, the project team conducts
      testing to detect the existence of failures, errors, and bugs. If our
      modernization solutions fail to function efficiently or if errors or bugs are
      detected in our tools, we may incur significant expenditures in an attempt
      to
      remedy the problem. The consequences of failures, errors, and bugs could have
      a
      material adverse effect on our business, operating results, and financial
      condition.




***If
      we fail to satisfy our customers’ expectations regarding our solutions, our
      contracts may be cancelled and we may be the subject of damages
      claims.***




In
      the
      event that we fail to satisfy our customers’ expectations from the results of
      the implementation of our solutions, or if we fail to timely deliver our
      solutions to our customers, these customers may suffer damages. When and if
      this
      occurs, customers may have the ability to cancel our contracts. Any cancellation
      of a contract could cause us to suffer damages, since we might not be paid
      for
      costs that we incurred in performing services prior to the date of cancellation.
      In addition, from time to time we may be subject to claims as a result of not
      delivering our products on time or in a satisfactory manner. Such disputes
      or
      others may lead to material damages.




***We
      are exposed to significant claims for damage caused to our customers’
information systems.***




Some
      of
      the products, tools, and services we provide involve key aspects of our
      customers’ information systems. These systems are frequently critical to our
      customers’ operations. As a result, our customers have a greater sensitivity to
      failures in these systems than do customers of other software products
      generally. If a customer’s system fails during or following the provision of
      modernization solutions or services by us, or if we fail to provide customers
      with proper support for our modernization solutions, we are exposed to the
      risk
      of a claim for substantial damages against us, regardless of our responsibility
      for the failure. We cannot guarantee that the limitations of liability under
      our
      product and service contracts, if any, would be sufficient to protect us against
      legal claims. We cannot assure you that our insurance coverage will be
      sufficient to cover one or more large claims, or that the insurer will not
      disclaim coverage as to any future claim. If we lose one or more large claims
      against us that exceed available insurance coverage, it may have a material
      adverse effect on our business, operating results, and financial condition.
      In
      addition, the filing of legal claims against us in connection with contract
      liability may cause us negative publicity and damage to our
      reputation.




***If
      third parties assert claims of infringement against us, we may suffer
      substantial costs and diversion of management’s
      attention.***




Substantial
      litigation over intellectual property rights exists in the software industry.
      Software products may be increasingly subject to third-party infringement claims
      as the functionality of products in different industry segments overlaps. We
      cannot predict whether third parties will assert claims of infringement against
      us. In addition, our employees and contractors have access to software licensed
      by us from third parties. A breach of the nondisclosure undertakings by any
      of
      our employees or contractors may lead to a claim of infringement against us.




9




Any
      claim, with or without merit, could be expensive and time-consuming to defend,
      and would probably divert our management’s attention and resources. In addition,
      such a claim if submitted may require us to enter into royalty or licensing
      agreements to obtain the right to use a necessary product or component. Such
      royalty or licensing agreements, if required, may not be available to us on
      acceptable terms, if at all.




A
      successful claim of product infringement against us and our failure or inability
      to license the infringed or similar technology could have a material adverse
      effect on our business, financial condition, and results of
      operations.




***We
      may experience greater than expected competition that could have a negative
      effect on our business***





We
      operate in a highly competitive market. Competition in the modernization field
      is, to a large extent, based upon the functionality of the available automated
      tools and personnel expertise. Our competitors may be in a better position
      to
      devote significant funds and resources to the development, promotion and sale
      of
      their modernization tools and services, thus enabling them to respond more
      quickly to emerging opportunities and changes in technology or customer
      requirements. Current and potential competitors have established or may
      establish cooperative relationships among themselves or with third parties
      to
      increase such competitors’ ability to successfully market their tools and
      services. We also expect that competition will increase as a result of
      consolidation within the industry. As we develop new tools and services, we
      may
      begin to compete with companies with which we have not previously competed.
      Our
      competitors include small vendors who may provide a single solution for a
      particular area of modernization, large system integrators such as IBM,
      Accenture, Cap Gemini and EDS, some of whom we also partner with and Indian
      system integrators such as Tata and Patni.





We
      may be
      unable to differentiate our tools and services from those of our competitors
      or
      successfully develop and introduce new tools and services that are less costly
      than, or superior to, those of our competitors. This could have a material
      adverse effect on our ability to compete.





Many
      of
      our existing and potential competitors may have or acquire more extensive
      development, marketing, distribution, financial, technological and personnel
      resources than we do. This increased competition may result in our loss of
      market share and pricing pressure which may have a material adverse effect
      on
      our business, financial condition and results of operations. We cannot assure
      you that competition with both competitors within our industry and with the
      in-house IT departments of certain of our customers or prospective customers
      will not result in price reductions for our tools and services, fewer customer
      orders, deferred payment terms, reduced revenues or loss of market share, any
      of
      which could materially adversely affect our business, financial condition,
      and
      results of operations.





***We
      may be unable to adequately protect our proprietary rights, which may limit
      our
      ability to compete effectively.***




Our
      success and ability to compete are substantially dependent upon our internally
      developed technology. Our intellectual property consists of proprietary or
      confidential information that is not subject to patent or similar protection.
      Our employees and contractors have direct access to our technology. In general,
      we have relied on a combination of technical leadership, trade secret, copyright
      and trademark law, and nondisclosure agreements to protect our proprietary
      know-how. Unauthorized third parties may attempt to copy or obtain and use
      the
      technology protected by those rights. Any infringement of our intellectual
      property could have a material adverse effect on our business, financial
      condition, and results of operations. Policing unauthorized use of our products
      is difficult and costly, particularly in countries where the laws may not
      protect our proprietary rights as fully as in the United States.




10




Pursuant
      to agreements with certain of our customers, we have placed, and in the future
      may be required to place, in escrow, the source code of certain of our software.
      Pursuant to the escrow arrangements, the software may, under specified
      circumstances, be made available to our customers. From time to time, we also
      provide our software directly to customers. These factors may increase the
      likelihood of misappropriation or other misuse of our software.




***We
      are exposed to litigation that could result in considerable financial
      liabilities.***




In
      July
      2003, a former Liraz shareholder filed an application with the Tel-Aviv-Jaffa
      District Court to approve a claim filed by him against us, as a class action.
      The claim relates to the acquisition of Liraz shares, which we completed in
      March 2003. The shareholder alleges that the share price we paid to Liraz’s
      shareholders in the tender offer and in a subsequent mandatory purchase was
      lower than the fair price of Liraz shares. The maximum amount of the claim
      is
      approximately NIS 33 million ($8.6 million) in the aggregate. Under Israeli
      law,
      the court’s approval is required for the plaintiff to represent all of the
      shareholders of Liraz who sold their shares to us pursuant to the tender offer
      and the mandatory acquisition. The plaintiff has applied for such approval
      in
      the lawsuit. If we are not successful in defending this claim, we could be
      exposed to considerable financial liabilities and, as a result, our financial
      condition could be materially adversely harmed.




***Our
      existing credit facilities contain a number of restrictions and obligations
      that
      limit our operating and financial flexibility, and there is no assurance that
      credit facilities will be available in the future.***




As
      of
      March 26, 2008, we had no outstanding loans under our credit facilities.
      However, to the extent we borrow under these facilities, we would be required
      to
      comply with certain restrictive covenants **.** Our
      credit facilities contain a number of restrictive covenants that limit our
      operating and financial flexibility. These covenants restrict, among other
      things, our ability to pledge our assets, dispose of assets, make loans or
      give
      guarantees, make certain acquisitions, and engage in mergers or consolidations.
      Our credit facilities also contain covenants regarding maintaining certain
      financial ratios. Our ability to continue to comply with these and other
      obligations depends in part on the future performance of our business. There
      can
      be no assurance that such obligations will not materially adversely affect
      our
      ability to finance our future operations or the manner in which we operate
      our
      business. In particular, any noncompliance with performance-related covenants
      and other undertakings of our credit facilities could result in an acceleration
      of our outstanding debt under our credit facilities and restrict our ability
      to
      obtain additional funds, which could have a material adverse effect on our
      business, financial condition, and results of operations. In addition, there
      is
      no assurance that banks will continue to provide us with credit facilities
      in
      the future.




11




**Risks
      Relating to International Operations**




***Marketing
      our tools and solutions in international markets may cause increased expenses
      and greater exposure to risks that we may not be able to successfully
      address.***




We
      intend
      to continue to expand our international operations, which will require
      significant management attention and financial resources. In order to continue
      to expand worldwide sales, we need to establish additional marketing and sales
      operations, hire additional personnel, and recruit additional resellers
      internationally. To the extent that we are unable to do so effectively, our
      growth is likely to be limited and our business, operating results, and
      financial condition will be materially adversely affected.




Risks
      inherent in our worldwide business activities generally include:




· currency
      exchange fluctuations;


· unexpected
      changes in regulatory requirements;


· tariffs
      and other trade barriers;


· costs
      of
      localizing products for foreign countries;


· lack
      of
      acceptance of localized products;


· longer
      accounts receivable payment cycles;


· difficulties
      in operations of management;


· potentially
      adverse tax consequences, including restrictions on the repatriation of
      earnings; and


· the
      burdens of complying with a wide variety of local legislation.





We
      cannot
      assure you that these factors will not have a material adverse effect on our
      future international sales and, consequently, on our business, operating
      results, and financial condition.




***Inflation,
      devaluation, and fluctuation of various currencies may adversely affect our
      results of operations, liabilities, and assets.***




We
      run
      our operations in various countries. As a result, we enter into transactions
      with customers and suppliers in local currencies. The reporting currency of
      our
      consolidated financial statements and the functional currency of our business
      is
      the U.S. dollar. The fluctuations in foreign currency exchange rates in
      countries where we operate can adversely affect the reflection of these
      activities in our consolidated financial statements. Fluctuations in the value
      of our non-dollar revenues, costs, and expenses measured in dollars could
      materially affect our results of operations. In addition, our balance sheet
      reflects non-dollar denominated assets and liabilities, which can be adversely
      affected by fluctuations in the currency exchange rates.




We
      enter,
      from time to time, into forward currency exchange contracts or other
      arrangements in order to hedge this foreign currency exposure. Such arrangements
      may not always be effective or sufficient to offset the fluctuations in currency
      exchange rates. For additional information relating to the exchange rates
      between different relevant currencies, see “Item 5.A. Operating Results–Our
      Reporting Currency”.




12




***Fluctuations
      in foreign currency values affect the prices of our products and services,
      which
      in turn may affect our business and results of
      operations.***




Most
      of
      our worldwide sales are currently denominated in U.S. dollars and euros while
      our reporting currency is the dollar. A decrease in the value of the dollar
      relative to foreign currencies, in particular the euro, Danish krone, and the
      NIS, would make our products more expensive and increase our operating costs
      and, therefore, could adversely affect our results and harm our competitive
      position in the markets in which we compete.




***We
      are subject to multiple taxing jurisdictions. If we fail to estimate accurately
      the amount of income tax due in any of these jurisdictions, our net income
      might
      be affected.***




We
      operate within multiple taxing jurisdictions and are subject to taxation by
      these jurisdictions at various tax rates. In addition, we may be subject to
      audits in these jurisdictions. These audits can involve complex issues, which
      may require an extended period of time to resolve. We cannot assure you that
      the
      final tax outcome of these issues will not be different from management
      estimates, which are reflected in our income tax provisions. Such differences
      could have a material effect on our income tax provision and net income in
      the
      period in which such outcome occurs.




**Risks
      Relating to Operations in Israel**




***Political,
      economic, and military conditions in Israel could negatively impact our
      business.***




Over
      the
      past several decades, a number of armed conflicts have occurred between Israel
      and its Arab neighbors. Major hostilities involving Israel or the interruption
      or curtailment of trade between Israel and its present trading partners could
      have a material adverse effect on our business, operating results, and financial
      condition. Since September 2000, there has been a high level of violence between
      Israel and the Palestinians. Hamas, an Islamist movement responsible for many
      attacks, including missile strikes against Israelis, won the majority of the
      seats in the Parliament of the Palestinian Authority in January 2006 and took
      control of the entire Gaza Strip, by force, in June 2007. These developments
      have further strained relations between Israel and the Palestinian Authority.
      Further, in the summer of 2006, Israel engaged in a war with Hezbollah, a
      Lebanese Islamist Shiite militia group, which involved thousands of missile
      strikes and disrupted most day-to-day civilian activity in northern Israel.
      Any
      armed conflicts, terrorist activities, or political instability in the region,
      may affect Israel’s security, foreign relations, and the stability of the
      region. Increased hostilities, future armed conflicts, political developments
      in
      other states in the region, or continued or increased terrorism could make
      it
      more difficult for us to conduct our operations in Israel, which could increase
      our costs and adversely affect our financial results. Furthermore, several
      countries restrict business with Israeli companies. In addition, nonexempt
      male
      adult citizens of Israel, including some of our officers and employees, are
      obligated to perform military reserve duty until the age of 40 or 45 depending
      on their function in the army, and are subject to being called for active duty
      under emergency circumstances. We cannot predict the full impact of such
      conditions on us in the future, particularly if emergency circumstances occur.
      If many of our employees are called for active duty, our operations in Israel
      and our business may be adversely affected.




13




***It
      may be difficult to serve process and enforce judgments against our directors
      and executive officers in Israel.***




We
      are
      organized under the laws of the State of Israel. Most of our executive officers
      and directors are nonresidents of the United States, and a substantial portion
      of our assets and the assets of these persons are located outside the United
      States. Therefore, it may be difficult to:




·
            effect
                service of process within the United States on us or any of our executive
                officers or directors who are nonresidents of the United
                States;


·
            enforce
                court judgments obtained in the United States including those predicated
                upon the civil liability provisions of the United States federal
                securities laws, against us or against any of our executive officers
                or
                directors that are nonresidents of the United States, in the United
                States
                or Israel; and


·
            bring
                an original action in an Israeli court against us or against any
                of our
                executive officers or directors to enforce liabilities based upon
                the
                United States federal securities
                laws.




**Risks
      Relating to Our Traded Securities**




***The
      market price of our ordinary shares may be volatile and our investors may not
      be
      able to resell the shares at or above the price they paid, or at
      all.***




During
      the past few years, the worldwide stock markets have experienced high price
      and
      volume fluctuations. The market prices of securities of technology companies
      have been extremely volatile, and have experienced fluctuations that have often
      been unrelated or disproportionate to the operating performance of those
      companies. These broad market fluctuations could adversely affect market price
      of our ordinary shares. The high and low market prices of our ordinary shares
      traded on the NASDAQ Global Market and the Tel Aviv Stock Exchange, or TASE,
      during each of the last three years, are summarized in the table
      below:




**NASDAQ
                Global**
              **Market**
            
            **TASE****In
                $**
            
            **In
                NIS**High
            
            Low
            
            High
            
            Low**2007**
            
            
            21.49
            
            
            5.94
            
            
            85.51
            
            
            25.69**2006**
            
            
            6.45
            
            
            3.85
            
            
            28.99
            
            
            18.30**2005**
            
            
            4.75
            
            
            3.81
            
            
            21.95
            
            
            16.01





Since
      January 1, 2008 and until March 26, 2008, the market price of our ordinary
      shares dropped from $19.19 to $9.06. We cannot assure you that the market price
      of our ordinary shares will rise to the same level as it was in the beginning
      of
      2008. The market price of our ordinary shares may continue to fluctuate
      substantially due to a variety of factors, including:




·
            any
                actual or anticipated fluctuations in our or our competitors’ quarterly
                revenues and operating results;


·
            shortfalls
                in our operating results from levels forecast by securities
                analysts;






14




·
            public
                announcements concerning us or our
                competitors;


·
            the
                introduction or market acceptance of new products or service offerings
                by
                us or by our competitors;


·
            changes
                in product pricing policies by us or our
                competitors;


·
            changes
                in security analysts’ financial
                estimates;


·
            changes
                in accounting principles;


·
            sales
                of our shares by existing shareholders;
                and


·
            the
                loss of any of our key personnel.





In
      addition, economic, political and market conditions, and military conflicts
      and,
      in particular, those specifically related to the State of Israel, may affect
      the
      market price of our shares.




***Our
      ordinary shares are traded on more than one market and this may result in price
      variations.***




Our
      ordinary shares trade on the NASDAQ Global Market and the TASE. Trading in
      our
      ordinary shares on these markets will take place in different currencies
      (dollars on the NASDAQ Global Market and NIS on the TASE), and at different
      times (resulting from different time zones, different trading days, and
      different public holidays in the United States and Israel). The trading prices
      of our ordinary shares on these two markets may differ due to these and other
      factors. Any decrease in the trading price of our ordinary shares on one of
      these markets could cause a decrease in the trading price of our ordinary shares
      on the other market.




***Future
      sales of our shares to be registered for resale in the public market could
      dilute the ownership interest of our existing shareholders and could cause
      the
      market price for our ordinary shares to fall.***




As
      of
      March 26, 2008, we had 20,907,929 ordinary shares outstanding (excluding
      1,647,594 held by two of our wholly owned subsidiaries). In addition, we
      reserved 1,300,628 ordinary shares for issuance under our option plan and
      restricted share units award plan. We also have the following commitments to
      issue our ordinary shares:




·
            485,714
                ordinary shares issuable upon exercise of warrants issued to institutional
                investors in connection with the $5 million and $3 million private
                placements, completed in March 2004 and March 2006,
                respectively;





·
            800,000
                ordinary shares issuable upon exercise of warrants issued by us to
                institutional investors in connection with the $35 million private
                placement completed in November 2007;
                and





·
            1,000,000
                ordinary shares issuable to certain shareholders of CodeStream, subject
                to
                certain conditions, pursuant to the purchase agreement between us
                and
                CodeStream , as amended in December 2007.





15




We
      registered for resale the shares underlying the warrants issued to the
      institutional investors in March 2004, March 2006 and November 2007, pursuant
      to
      registration rights agreements entered into with such investors. For more
      information, see “Item 4.B - Business Overview – Investments and
      Acquisitions” and “Item 5.B – Liquidity and Capital Resources - Contractual
      Commitments and Guarantees.”




Pursuant
      to the purchase agreement between us and CodeStream, as amended in December
      2007, we granted to certain shareholders of CodeStream registration rights
      with
      respect to 1,000,000 ordinary shares that may be issued as contingent
      consideration for the purchase of CodeStream activity, if certain conditions
      are
      met. For more information, see “Item 4.B. Business Overview-Investments and
      Acquisitions- CodeStream Software Ltd.”




The
      exercise of options by our employees and the exercise of warrants by investors
      would dilute the ownership interests of our existing shareholders. Any sales
      in
      the public market of our ordinary shares issuable upon exercise of options
      or
      warrants could adversely affect the market price of our ordinary shares. If
      a
      large number of our ordinary shares are sold in a short period, the price of
      our
      ordinary shares would likely decrease.




***Our
      U.S. investors could suffer adverse tax consequences if we are characterized
      as
      a passive foreign investment company.***





Although
      we believe that we were not a passive foreign investment company, or PFIC,
      in
      2007, we cannot assure you that the United States Internal Revenue Service
      will
      agree with our position. We would be a PFIC if (i) 75% or more of our gross
      income in a taxable year (including our pro rata share of the gross income
      of
      any company treated as a corporation for U.S. federal income tax purposes in
      which we are considered to own directly or indirectly 25% or more of the shares
      by value) is passive income, or (ii) the value of our assets averaged quarterly
      over our the taxable year (including our pro rata share of the assets of any
      company treated as a corporation for U.S. federal income tax purposes in which
      we are considered to own directly or indirectly 25% or more of the shares by
      value) that produce, or are held for the production of; passive income is at
      least 50%. Passive income includes interest, dividends, royalties, rents and
      annuities. If we are or become a PFIC, our U.S. investors could suffer adverse
      tax consequences, including being taxed at ordinary income tax rates and being
      subject to an interest charge on gain from the sale or other disposition of
      our
      ordinary shares and on certain distributions with respect to our ordinary
      shares). For additional information regarding our PFIC status, see the
      discussion under “Item 10.E. Taxation — United States Federal Income Tax
      Considerations — Tax Consequences If We Are a Passive Foreign Investment
      Company.”




16




**ITEM
      4. INFORMATION ON THE COMPANY**




**A.**  **History
      and Development of the Company**





We
      were
      incorporated in Israel in 1987 under the name A. Crystal Solutions Ltd. In
      1996,
      we changed our name to Crystal Systems Solutions Ltd. In 2003, following the
      acquisition of Liraz Systems Ltd., we changed our name to BluePhoenix Solutions
      Ltd. Our registered office is located at 8 Maskit Street, Herzliya, 46733 Israel
      and our telephone number is 972-9-9526110. Our agent in the United States
      is **** Blue
      Phoenix Solutions USA Inc., 8000 Regency Parkway, Cary, NC 27511 United States
      and its telephone number is (919) 380-5100.




**B.**  **Business
      Overview**




***Our
      Business***





We
      develop and market unique value driven enterprise IT modernization, or EIM,
      solutions that enable companies to automate the process of modernizing and
      upgrading their mainframe and distributed IT infrastructure in order to more
      effectively compete in today’s business environment. The combination of our
      comprehensive tools and services with our unique methodology provides an
      efficient and cost-effective process for extending the return on investment
      of
      existing enterprise IT assets. Our complete modernization solutions consist
      of a
      combination of automated technologies and services that minimize the risk
      through the whole life cycle of the modernization process. Our solutions are
      based on technologies that support the four phases of the process, which we
      call: Understanding, Migration, Remediation, and Redevelopment. The solutions
      allow companies to fully leverage their current systems and applications, speed
      up and reduce the cost of the renewal process, and effectively update their
      systems in order to adapt to new business demands. In addition, by using our
      technologies our customers gain the added value of extending their systems
      to be
      ready for future demands, such as service oriented architecture, or SOA. Our
      modernization solutions are offered to customers in all business market sectors,
      particularly financial services, automotive and governmental entities. In
      addition, we provide consulting services such as application development
      services and maintenance for core banking systems.





Our
      solution portfolio includes software products, software tools, and services
      that
      address the most pressing IT challenges which organizations and companies face
      today, including:





· lack
      of
      agility and responsiveness to changing business needs;


· difficulty
      in recruiting and retaining mainframe professionals;


· growing
      cost of software licenses, maintenance and operations;


· lack
      of
      packaged software and new applications; and


· difficulties
      in complying with new regulations.




17





Our
      solutions enable companies to:





·
            effectively
                plan and carry out strategic projects that provide real business
                value;


·
            better
                understand and manage their IT systems and
                resources;


·
            easily
                integrate packaged applications and build customized
                applications;


·
            significantly
                decrease maintenance, human resource, and technology costs;


·
            quickly
                migrate to modern databases, platforms, applications, and programming
                languages with a proven suite of tools and
                services;


·
              substantially
                  transform applications and databases in order to address regulatory
                  and
                  business changes; and


·
            directly
                gain access to cutting edge technology and new business
                channels.





Our
      comprehensive enterprise technologies span mainframe, midrange, and
      client/server computing platforms. We have enhanced our expertise through the
      successful completion of projects for many large organizations over the past
      two
      decades, establishing our credibility and achieving international recognition
      and presence. Based on our technology and that of our affiliates, we develop
      and
      market software products, tools, and related methodologies. We deliver our
      tools
      and methodologies together with training and support in order to provide
      enterprises with comprehensive solutions, primarily for the modernization of
      existing IT systems.




***Market
      Background***





Companies
      initiate IT modernization projects for a wide range of reasons, such
      as:





·
            maintaining
                a competitive edge in the market;


·
            addressing
                changing business needs;


·
            complying
                with new regulations;


·
            reducing
                maintenance, human resources, and technology costs;
                or


·
            gaining
                access to cutting edge technology and new business
                channels.





Alternatives
      to modernization include, among others, renewing legacy systems, buying packaged
      software, or rebuilding entire applications. Enterprise IT modernization has
      proven to be the most efficient and viable way for companies to protect their
      existing investments. We provide a range of solutions designed to efficiently
      address the challenge of retaining the business knowledge built into the
      application code while updating the system to reflect new
      requirements.





The
      EIM
      market is divided into the following categories:





*Enterprise
      IT Understanding* —These
      solutions enable companies to make informed strategic decisions regarding the
      future of their IT systems by automatically capturing multiple levels of
      operational and development information into a consolidated metadata warehouse.
      Our tools facilitate global assessments and impact analyses of application
      assets, thus helping reduce costs, streamline working processes, and increase
      efficiency.




18





*Enterprise
      IT Migration* —These
      solutions enable companies to consolidate and eliminate a wide range of legacy
      hardware and software through automated migration of applications, databases,
      platforms, programming languages, and data. These tools help to reduce costs
      and
      resources, and minimize reliance on proprietary technology, sunset products,
      and
      dwindling skill sets. Our SOA-ready solution is provided as a post-migration
      service, allowing customers to extend their development environment by providing
      access to mainframe systems through Web services protocols, making legacy
      systems appear as modern systems.





*Enterprise
      IT Remediation* —These
      solutions enable companies to extend the life of their existing IT systems
      by
      quickly adapting to new regulatory changes and business requirements. These
      automated tools can be easily customized to fit any IT environment and corporate
      need, including data field adjustment, IT standardization, and system
      consolidation.





*Enterprise
      IT Redevelopment* —These
      solutions enable companies to mine existing applications by extracting business
      rules, data flows, and data models, and then re-using the proven code base
      to
      create more flexible Java/Web-based applications. Our tools help to reduce
      maintenance costs and resources and application development
      time-to-market.





***Enterprise
      IT Understanding***





In
      the
      current lean budgetary environment, companies that want to extend the return
      on
      investment of their existing systems need to modernize their legacy systems.
      Since modernization projects are intricate and complex, the essential first
      step
      is a thorough review of existing IT assets.





Our *understanding* solutions provide automated, detailed mapping of system-wide IT activity and
      the
      interconnections between all software components. This detailed road map serves
      as the basis for optimizing the re-use of existing IT systems, tailoring the
      modernization plan for the company’s unique IT environment and corporate
      requirements, and reducing future ongoing maintenance costs.





Modernization
      initiatives that need to be based on an in-depth examination of actual system
      elements include:





·
            building
                and rewriting enterprise-scale application
                components;


·
            implementing
                new technologies such as
                Web-enablement;


·
            integrating
                purchased and newly written
                applications;


·
            consolidating
                servers and applications;


·
            migrating
                to more modern platforms, databases and
                languages;


·
            transforming
                current applications to adapt to changing business standards;
                and


·
            protecting
                against the loss of critical personnel and corporate knowledge
                base.





Our
      integrated set of *enterprise
      IT understanding* solutions are designed to assist companies in achieving these goals by
      accurately mapping raw IT operational and development data, down to the program
      code level, into a consolidated enterprise-wide warehouse. The gathered
      information enables companies to keep track of system inventories, resources,
      and inter-relationships and to intelligently mine systems and application
      metadata.




19





This
      enterprise-wide view can then be used for a variety of strategic purposes,
      including:





·
            performing
                impact, cost, and trend analyses as well as ongoing tracking of IT
                resources, inventories, components, their usage and their
                inter-relationships;


·
            running
                business-logic analyses for business process identification, evaluation,
                extraction, transition and
                enhancement;


·
            achieving
                significant cost reductions through the elimination of unused products,
                unnecessary software upgrades, inefficient storage allocations, and
                wasteful CPU usage; and


·
            providing
                more efficient application development by reusing systems and leveraging
                existing business rules.





*BluePhoenixTM
      IT Discovery* —This
      solution provides fast and convenient access to application inventory,
      dependency, and operational information. This tool performs the complete audit
      necessary to enable companies to define and analyze all application assets
      in
      order to make informed decisions about ongoing modernization activities. *IT Discovery* provides
      the ability to analyze on a refreshable basis numerous technology environments,
      and from them extract and report on the inter-relationships among the components
      that make up these environments. In this manner, it provides an organization
      the
      ability to discover information about its current systems, thereby insuring
      that
      ongoing decisions are made based on an accurate audit of the current
      environment.





*BluePhoenixTM
      LogicMiner* —This
      recovery solution mines COBOL and extracts business rules from the legacy code,
      thus providing IT departments with the ability to begin a modernization process
      based on techniques that preserve the functionality of legacy code. This tool
      retains past investments in software assets by producing reusable code objects
      or descriptive data that can later be used for improving the quality of the
      legacy code, rewriting the legacy application, or building a full modernization
      plan. LogicMiner increases a system’s manageability, while eliminating rules
      that no longer apply to current business procedures.





***Enterprise
      IT Migration***





Our
      comprehensive, integrated set of *enterprise
      IT migration* solutions enable companies to standardize and consolidate their IT systems
      by
      automatically converting and redeploying applications, databases, platforms,
      programming languages and data that are implemented on outdated computing
      platforms.





Buying
      a
      packaged application or rebuilding one can often be an expensive and risky
      proposition. Therefore, companies often look towards migrating their existing
      applications. This option is much more cost-effective and time-efficient as
      it
      leverages their existing investments in custom applications. Additionally,
      our
      migration solutions enable companies to operate their IT systems independently,
      without relying on previous technology support providers. Thus, the migration
      process provides significant cost savings on development, maintenance, and
      human
      resources.




20





Our
      migration solutions provide numerous advantages, including:





·
            significantly
                decreasing project costs, risk of errors and
                time;


·
            preserving
                corporate business knowledge;


·
            substantially
                reducing dependency on scarce skill
                sets;


·
            solving
                problematic maintenance issues;


·
            enabling
                end-to-end project control and
                management;


·
            directly
                supplying a full audit trail and documentation of all
                changes;


·
            minimizing
                system freeze time with a unique “refresh” feature;
                and


·
            comprehensively
                working with most mainframe and non-mainframe
                platforms.




The *enterprise
      IT*  *migration* suite
      includes the following solutions:





*BluePhoenixTM
      DBMSMigrator—* An
      automated migration tool that converts applications from nonrelational
      databases, such as IDMS (Integrated Database Management System), ADABAS, IMS,
      and VSAM, to relational databases, such as DB2, Oracle, and SQL Server. The
      tool
      performs automated conversions that provide companies with fully functional
      compliance for source and target applications and minimal application,
      functional, and logical program flow changes. *DBMSMigrator* leaves
      no residuals, emulation software, or translation procedures and allows system
      support to continue uninterrupted during the migration project. As a result
      of
      the conversion process, the migrated application operates more efficiently,
      is
      easier to maintain, and contains complete documentation of the customer’s
      knowledge base and guidelines.





*BluePhoenixTM
      PlatformMigrator—* An
      automated migration tool that converts ** a
      range
      of platforms, including VSE, MVS, ICL and Bull GCOS, to Unix, Linux, Windows,
      and .Net. *PlatformMigrator* can
      be ** customized
      to fit the unique IT configuration and business rules of each customer site.
      The
      tool converts platforms to a pure, native installation so that programs are
      not
      required to run under emulation or through translation techniques. *PlatformMigrator* solutions assist companies with maintaining service levels, setting and
      upgrading standards, implementing the new IT environment, training IT users,
      implementing new facilities like a security system or a batch scheduler, and
      testing for functional equivalence.





*BluePhoenixTM
      Rehosting—* Organizations
      implement mainframe rehosting in order to reduce the ongoing costs of existing
      legacy CICS and batch applications. Rehosting leverages the strength and
      investment of older COBOL applications while taking advantage of new,
      cost-efficient hardware and open operating system environments such as Linux,
      Unix, Windows, J2EE, and .NET.




21





Using
      our
      various automated migration tools, and cooperating with our partners, we offer
      COBOL and
      RPG migration s,
      iSeries and
      mainframe rehosting solutions. We formed the following alliances for providing
      these solutions:





·
            an
                alliance with Clerity for assisting companies to rehost mainframe
                applications on more cost-efficient, open platforms;


·
            a
                collaboration withFujitsufor assisting companies to migrate COBOL/CICS applications intoFujitsu
                NetCOBOLand the Fujitsu NeoKicks and NeoBatch environments for handing CICS
                and
                batch/JCL;


·
            a
                Gold level partnership with Microsoft for collaboration in migrating
                customers’ applications to the .NET platform;


·
            a
                partnership with Oracle for assisting companies to migrate their
                legacy
                databases to the Oracle database;


·
            advanced
                membership in IBM’s Partnerworld program to work together with IBM to
                modernize customers’ databases and applications on the mainframe platform;
                and


·
            ongoing
                cooperation with SUN that focuses on rehosting customers off of the
                mainframe and onto SUN’s UNIX platform.





*BluePhoenixTM
      LanguageMigrator—* An
      automated migration tool for converting COBOL and 4GLs (fourth generation
      languages) such as ADSO, Natural, ALLFusion Gen (formerly COOL: Gen), Mantis,
      and PowerBuilder to COBOL and Java/J2EE. This reliable, time-efficient, and
      comprehensive solution enables site-wide installation, simultaneous testing,
      and
      implementation of batch programs. In addition, *LanguageMigrator* identifies the compatibility of the code, converts it to the new standards
      required by customers, and analyzes converted programs to identify potential
      problems. For more information about future developments of this tool, see
      “Research and Development.”





*BluePhoenixTM
      DataMigrator—* A
      Windows-based tool for migrating data between various data system environments.
      Coupled with a step-by-step proven methodology, the tool provides a fully
      structured but still versatile automated data migration process. *DataMigrator* enables
      full control of source and target data definitions resulting in consistent,
      accurate, highest quality target data with no data loss, and efficient
      utilization of available resources. In addition, it provides support for partial
      or incremental migration and for multiple runtime environments.





*BluePhoenixTM
      SOA-Ready Enablement* —This
      post-migration service extends the useful life of valuable legacy applications
      that run on historic mainframe platforms by allowing them to be easily reused
      in
      a modern Web-centric environment. This comprehensive solution provides Web
      services and Web customers for legacy applications. This unique set of tools
      enables the exposure of a legacy application to more modern applications written
      in Java or .NET by providing a Web service interface for the legacy system.
      Our
      tools also provide a Web-based display for legacy (3270) applications. These
      tools are noninvasive and allow the legacy application to remain
      untouched.




22





***Enterprise
      IT Remediation***





Our
      integrated set of *enterprise
      IT remediation* solutions enable companies to extend the life of their existing IT systems
      when
      facing ongoing regulatory changes and new business requirements. Our *remediation* solutions address a variety of corporate needs and include:





*BluePhoenixTM
      FieldEnabler—* New
      business decisions or regulatory requirements often require companies to make
      changes that impact a wide range of system components. These include field
      adjustments that involve changes in the type, length, and structure of a
      database or program field, such as expanding a dealer code. *FieldEnabler* is a
      rule-based tool that enables a step-by-step, comprehensive process for making
      these kinds of modifications across an enterprise in a reliable and
      time-efficient manner.





*BluePhoenixTM
      StandardsEnabler—* A
      highly
      automated solution for reliably facilitating system consolidation into a single
      set of naming standards. Since all resources being converted must be changed
      in
      parallel, the large task of manually standardizing the naming of system
      components is not practical. Our tool provides an automated solution addressing
      this problem.





*BluePhoenixTM
      COBOL/LE-Enabler—* A
      highly
      automated solution that facilitates the migration of COBOL code from non-LE
      compliant environments to LE compliant environments.





*BluePhoenixTM
      EuroEnabler—* A
      highly
      automated solution that enables the transformation of applications to be euro
      compliant. *EuroEnabler* fully
      preserves system and data integrity and helps to maintain existing levels of
      system application development and maintenance throughout the
      process.





***Enterprise
      IT Redevelopment***





Enterprise
      IT environments are complex, and can prevent companies from quickly and easily
      adapting to new business needs and requirements. The more companies can organize
      and understand their applications, the faster they can adapt to inevitable
      changes. While organizations are mostly satisfied with the existing business
      functionality of their applications, they usually want to improve their business
      processes and leverage technologies such as Web-enabled and service-oriented
      architectures. Additionally, they are eager to find a way to decrease their
      maintenance costs, which typically consume 70%-80% of total IT
      spending.





Our *enterprise
      IT redevelopment* suite
      enables companies to efficiently mine, reuse, and rewrite their existing
      applications, thus incrementally redeveloping their legacy systems, extending
      them into new technologies, and saving on development and programmer
      costs.





*BluePhoenixTM
      AppBuilder* —Our
      primary redevelopment legacy environment has been used for managing,
      maintaining, and reusing the complicated applications needed by large
      businesses. It provides the infrastructure for enterprises worldwide, across
      several industries, with applications running millions of transactions daily
      on
      legacy systems. Enterprises using *AppBuilder* can
      build, deploy, and maintain large-scale custom-built business applications
      for
      years without being dependent on any particular technology until they cease
      using their legacy infrastructure.


*AppBuilder* acts
      like a virtual application warehouse, keeping the underlying structure of the
      system in an organized framework such that developers can easily understand
      it.
      This allows companies to reuse critical business components, realizing a
      long-term return on investment for both new and existing
      applications.




23





*BluePhoenixTM*  *Redevelopment
      —* Based
      on
      AppBuilder and LogicMiner, *Redevelopment* transforms
      legacy COBOL programs into service oriented applications deployed on the latest
      platforms. The resulting application conforms to industry standards and is
      written in clean, maintainable source code. This conformance to standard
      architectures, such as full object-orientation and Web services, is a key
      differentiator in the *Redevelopment* approach
      when compared to more common migrations. Instead of using the common approach
      where each line of COBOL source code is translated to one or more statements
      in
      the target language (known as 1-1 approach), *Redevelopment* uses a
      model based approach. *Redevelopment* develops
      a platform independent model from platform specific models of legacy COBOL
      applications identified by *BluePhoenix
      LogicMiner* .
      This
      platform independent model may then be extended to meet new business
      requirements. Finally the application is generated to J2EE, .NET, or
      COBOL.




***The
      AS/400 / iSeries Family of Products***




We
      develop and market a separated but complementary family of products that
      provides similar solutions for AS/400 (also known as iSeries/System i)
      applications. The products described hereunder cover the areas of *understanding,
      migration* and *redevelopment* .





*ASNA
      Monarch TM* —
This
      product is used for *understanding* and *migration* of
      AS/400 applications. It ** transforms
      applications originally written in RPG/400 into native and fully compliant
      Microsoft.NET®. It can also migrate the originating database to SQL Server, thus
      providing for a full re-platforming solution. *ASNA
      Monarch* reuses
      the original source code, which persists in a familiar syntax, allowing the
      existing development teams to maintain it.





*ASNA
      Visual RPG® (AVR)* is a
      modern implementation of RPG that enables RPG developers to easily build Web
      and
      Windows applications.  AVR provides direct, secure and fast access to both
      files and program objects on IBM's System i (formerly known as
      iSeries, AS/400) server. Using a familiar, but modernized syntax, RPG
      programmers can quickly apply their long-standing RPG experience to create
      modern applications that connect seamlessly to the System i (iSeries, AS/400)
      platform.




*AVR
      for .NET* provides
      similar functionalities under Microsoft's .NET framework.  It enables
      modernizing existing RPG applications, develop Web services, and extend System
      i
      applications to .NET and the inherent support in service oriented architecture
      while continuing to program with a familiar, RPG-like syntax. AVR for .NET
      is the only development solution available for Microsoft's .NET that
      specifically supports high performance access to the System
      i database.




24





*ASNA
      DataGate®* — *ASNA
      DataGate* provides
      fast and secure iSeries-400 database access. Applications written to access
      the
      iSeries through *DataGate* can
      later
      be connected to SQL Server without modification. A single application may
      connect to both platforms concurrently, or an application may switch,
      automatically, from one platform to the other in the case of a failover
      situation.





*ASNA
      Visual RPG®* and *ASNA
      DataGate®* are used
      for *migration* and *redevelopment* solutions.





***Investments
      and Acquisitions***





In
      order
      to enhance our solutions and services portfolio, we have been pursuing a
      strategy of adding new technologies to our suite of automated modernization
      tools. We implement this strategy via internal development of new software
      tools
      and through acquisitions and investments. Accordingly, we devote significant
      resources to the development and marketing of new software modernization tools,
      and invest in businesses that develop
      software tools that are complementary to our existing portfolio. The broad
      portfolio that we established, among others, through these acquisitions,
      contributes to our ability to penetrate new markets and to offer a complete
      set
      of solutions addressing the broad array of changing demands of our
      customers. We
      integrate the acquired businesses into our business and assimilate many of
      their
      functions, including, marketing, sales, finance and administration into our
      existing infrastructure.





Following
      is a description of our investments and acquisitions, which form a part of
      our
      business as described above:





***ASNA.*** In
      August 2007, we entered into an agreement to purchase the entire outstanding
      share capital of Amalgamated Software North America Inc. (ASNA), a private
      company based in San Antonio, Texas, for a total consideration of $7 million.
      Under the terms of the transaction, we agreed to pay to the selling shareholders
      an additional consideration if certain criteria are met, based on ASNA's
      earnings before interest and taxes. Accordingly, during the period from August
      15, 2007 to December 31, 2007, additional consideration of $746,000 was accrued.
      We shall be required to pay to the selling shareholders an additional amount,
      calculated incrementally, based on a multiplier of between 6.5 times to 8 times
      of ASNA's average net profit in 2008 and 2009, if the average annual net profit
      during these years exceeds a certain level.





ASNA’s
      product, Monarch, is a fully integrated solution for transforming RPG
      applications to the Microsoft.NET® platform. ASNA is a Microsoft Gold Certified
      Partner, a Microsoft Visual Studio Industry Partner, an IBM Tools Network
      Partner, and an Advanced Tier Member of IBM’s PartnerWorld. Through the
      acquisition, BluePhoenix expects to expand its modernization offering to
      enterprises running legacy applications on the IBM AS/400, iSeries, and System
      i
      who are facing the mounting challenge of modernizing their RPG-based
      applications, by providing these enterprises both software tools and services
      required to perform these tasks successfully.




25





***BridgeQuest.*** Effective April 2007, we entered into an agreement to purchase the entire
      outstanding share capital of BridgeQuest Inc., a North Carolina corporation
      that
      manages and operates, through a wholly owned subsidiary, a professional
      outsourcing center in St. Petersburg, Russia. BridgeQuest is experienced in
      providing development services from the Russian Federation. The consideration
      amounted to $2 million. Under the terms of the transaction, as amended by the
      parties in January 2008, we issued to the selling shareholders an option to
      purchase 200,000 of BluePhoenix’ ordinary shares and paid the selling
      shareholders an additional consideration computed based on BridgeQuest revenues
      and earnings before interest and taxes, during the period from April 1, 2007
      to
      December 31, 2007. We agreed to pay the selling shareholders additional
      consideration calculated incrementally based on a multiplier of between 4 times
      to 5.5 times of BridgeQuest's average operating profit in 2008 and 2009.




***CodeStream
      Software Ltd.*** In
      December 2006, we acquired from a company incorporated in the United Kingdom,
      CodeStream Software Ltd., certain business activities in the field of
      modernization of legacy databases, particularly IDMS and other mainframe
      platforms. Pursuant to the purchase agreement, we hired 18 persons previously
      employed by CodeStream and assumed all the obligations in respect of the
      purchased activities. In consideration thereof, we paid to CodeStream **₤** 5.2
      million (approximately $10.2 million). Pursuant to the purchase agreement,
      as
      amended in December 2007, we committed to pay to CodeStream £425,000
      (approximately $842,000) of which £390,000 (approximately $800,000) was already
      paid. Additional consideration of $300,000 was paid in January 2008 and $1
      million should be paid in October 2008. Consequently, an amount of $2.1 million
      was recorded as contingent consideration against goodwill. In addition, as
      a
      contingent consideration for the purchased activity, we undertook to issue
      to
      the selling shareholders 400,000 BluePhoenix ordinary shares by March 31, 2008
      and an additional 600,000 ordinary shares by March 31, 2009, if certain
      conditions are met. In the event that the volume weighted average price per
      ordinary share on the NASDAQ Global Market during a consecutive 10-day trading
      period is less than $6.00, the grantees of such shares may request cash payments
      of £1.2 million (approximately $2.3 million) and £1.7 million (approximately
      $3.4 million), respectively, in lieu of the issuances of ordinary shares. The
      amounts stated in this paragraph are based on the applicable exchange rate
      on
      December 31, 2007, or, in the event that the payment was already executed,
      according to the actual payment date.





***BluePhoenix
      Solutions Srl. (previously known as AlphaTech (2000)
      Srl.).*** In
      December 2002, we purchased from Intercomp, our affiliate, a 65% controlling
      interest in AlphaTech (2000) Srl. In February 2005, we entered into an agreement
      with the other shareholder of AlphaTech to purchase for $250,000 its entire
      holdings in AlphaTech, which as of such date was equal to 35% of AlphaTech’s
      outstanding share capital. In 2005, AlphaTech changed its name to BluePhoenix
      Solutions Srl. BluePhoenix Solutions Srl., a company incorporated in Romania,
      serves as our offshore delivery center in Romania.





***CePos*** ***t.*** In
      January 2004, we purchased the entire outstanding share capital of CePost Ltd.,
      an Israeli company that develops and markets software solutions for electronic
      document mining, management and presentment. Pursuant to the purchase agreement,
      we undertook to pay to the sellers royalties from CePost’s revenues in an amount
      of up to $1.5 million. In accordance with the purchase agreement, we paid to
      the
      sellers in 2005 and 2006 advances in an aggregate amount of $45,000 on account
      of the royalties. No additional royalties are expected.




26





***Intercomp.*** In 1998,
      we initially invested in Intercomp Ltd, which developed a set of automated
      analysis and reengineering tools for legacy COBOL applications. Following a
      series of subsequent transactions, pursuant to which we issued to certain
      shareholders of Intercomp 100,719 of BluePhoenix ordinary shares in the first
      quarter of 2007, we now wholly own Intercomp. In the first quarter of 2006,
      First Israel Mezzanine Investors Ltd., FIMI, a creditor of Intercomp, completed
      the exercise of a put option to sell us a convertible promissory notes issued
      by
      Intercomp, in an aggregate principal amount of $3.5 million. The put option
      was
      originally granted to FIMI in January 2001. As consideration thereof, we paid
      to
      FIMI, in 2006, an aggregate amount of $4.48 million including interest accrued,
      which equals the book value of the promissory notes, and issued to FIMI warrants
      to purchase 210,000 BluePhoenix ordinary shares at an exercise price of $4.00
      per share. No gain or loss was recorded at the repayment date. In the first
      quarter of 2007, FIMI exercised the warrants for a total exercise price of
      $840,000.





***I-Ter/Informatica
      & Territorio S.p.A.*** In
      the
      second quarter of 2005, we entered into an agreement to purchase the entire
      outstanding share capital of I-Ter/Informatica & Territorio S.p.A., referred
      to as I-Ter. Pursuant to the purchase agreement, we paid to the selling
      shareholders of I-Ter $1.4 million. In addition, under the terms of the
      agreement, we agreed to pay the selling shareholders an additional contingent
      consideration based on I-Ter’s earnings before interest and taxes, for the years
      2005 through 2007. The accrued contingent consideration was calculated on
      December 31, 2007 and amounted to $5.1 million which was recorded as goodwill
      and $480,000 of which has been paid as of December 31, 2007.





***Outlook.*** Effective
      as of January 2004, we acquired from an Israeli company, Outlook Systems Ltd.
      through a new wholly-owned subsidiary, Outlook & BluePhoenix Ltd., Outlook
      Systems’ entire business activities in Israel in the field of research and
      development services. Pursuant to the purchase agreement, we hired 31 employees
      previously employed by Outlook Systems and assumed all the obligations in
      respect of the purchased activity. Under the purchase agreement, as amended
      in
      2006, we paid to Outlook Systems an aggregate amount of approximately $1.3
      million. In accordance with the amendment to the purchase agreement, a guarantee
      given by us to secure bank loans of Outlook Systems was cancelled, and Outlook
      Systems received, in 2006, 138,591 of BluePhoenix ordinary shares. Additional
      consideration for the amount of $174,000 was due and paid in 2007. In addition,
      under the terms of the agreement, we agreed to pay the selling shareholders
      an
      additional contingent consideration based on Outlook’s earnings before interest
      and taxes for the three years commencing on July 1, 2005. The accrued contingent
      consideration for 2007 amounted to $20,000.





**Zulu
      Software Inc.** In
      February 2005, we entered into an agreement to purchase up to 20% of the
      outstanding share capital of Zulu Software, Inc., or Zulu, on a fully diluted
      basis. Under the purchase agreement, the purchase price was divided into four
      installments, each to be paid subject to fulfillment of certain milestones.
      We
      paid the first installment of $350,000 in February 2005 against the issuance
      of
      8% of Zulu’s outstanding share capital. We did not make additional payments
      since the agreed upon milestones have not been met. In January 2006, we
      purchased from the other shareholders of Zulu additional shares increasing
      our
      holdings to 72% of Zulu’s outstanding share capital. The aggregate consideration
      paid for this additional purchase was $2.4 million.




27




The
      consideration for the acquisition was attributed to net assets on the basis
      of
      fair value of assets acquired and liabilities assumed. Based upon a purchase
      price allocation, the purchase price was allocated to the purchased technology
      in the amount of $3.5 million, and is amortized over a 5-year period. For more
      information about Zulu’s software solutions, see “Enterprise IT
      Migration—BluePhoenix *TM* LanguageMigrator.”





***TIS
      Consultants Ltd*** .
      In
      January 2008, we entered into an agreement for the purchase of the entire
      outstanding share capital of TIS Consultants Ltd., or TIS, a company
      incorporated in Cyprus, that wholly owns a subsidiary incorporated in India,
      TISA Software Consultants Private Limited. Under the agreement, upon the closing
      of the transaction, we will pay the selling shareholders an aggregate of
      $500,000. In addition, we undertook to pay contingent consideration equal to
      5.5
      times the average operating profit of TIS in 2008, 2009 and 2010. In connection
      therewith, we will pay nonrefundable down payments in March 2009, March 2010
      and
      March 2011, in each case based on the operating profit in the previous years.
      Furthermore, we undertook to pay additional incremental consideration based
      on
      the growth in TIS revenues in the years 2008, 2009 and 2010 in an amount of
      up
      to 35% of the growth in TIS revenues in each of these years compared to TIS
      revenues in the previous year. Thirty days after the closing of the transaction,
      we will pay the selling shareholders $700,000 as a nonrefundable advance payment
      on account of the contingent consideration. TIS provides consulting services,
      solutions and value added products to the banking industry, specializing in
      the market
      for Temenos GLOBUS/T24TM.





***Cicero
      Inc.*** *(formerly
      Level 8 Systems Inc.)* . As
      of
      March 26, 2008, we hold several capital instruments, including warrants and
      rights to receive warrants, exercisable into shares of Cicero Inc., or Cicero. Pursuant
      to an agreement signed on October 30, 2007 with Cicero, we repaid $1.7 million
      on behalf of Cicero to Bank Ha’Poalim to cover part of Cicero’s credit facility
      with the bank. In
      connection therewith, a $2 million bank guarantee that BluePhoenix previously
      provided to Bank Ha’Poalim to secure Cicero’s bank loans, was released. As
      consideration therefore, Cicero issued to BluePhoenix (a) a $1,021,000 senior
      promissory note, bearing an annual interest rate of LIBOR+1% (or in the event
      of
      any unpaid interest, LIBOR+4%) payable in two installments; the first
      installment of $350,000 due on January 30, 2009 and the second installment
      of
      $671,000 due on December 31, 2011; and (b) 2,546,149 ordinary shares of Cicero.
      Cicero committed to register these shares for trading. If Cicero does not
      register the shares for trading, Cicero will be required to issue to us
      additional shares. As of December 31, 2007, we held 2,709,922 ordinary shares
      of
      Cicero.




***Discontinued
      Operations***




In
      January 2008, our board of directors announced its intent to sell our holdings
      in Mainsoft, in which we hold a 58% controlling interest. This decision followed a
      strategic shift in Mainsoft's product development and marketing strategy outside
      of BluePhoenix's core business focus. For the period commencing January 1,
      2008
      and until Mainsoft is sold, we will include Mainsoft’s results in our financial
      statements as a discontinued operation, in accordance with SFAS 144.




28




***Customers***





We
      provide our modernization solutions directly or through our strategic partners,
      such as IBM, Electronic Data System Ltd. (EDS), NCS Pte Ltd., Mann India, and
      Sun Micro Systems. Additionally, from time to time, other IT services companies
      license our technologies for use in modernization projects in various markets.
      Our partners include system integrators, as well as other software vendors
      such
      as Oracle and Microsoft, who assist us in increasing our penetration and
      exposure in the market. We
      provide solutions to our partners’ customers in collaboration with the system
      integrator’s team. In most cases, the partners provide related services to the
      customers. Our arrangements with our partners vary. We may enter into
      distribution agreements under which we grant license rights to our partners
      or
      to the partners’ customers or provide related services, or a combination of
      both. Alternatively, we may enter into subcontractor relationships with our
      strategic partners.





Some
      of
      our agreements are fixed price contracts. These projects bear some risks and
      uncertainties as we price these contracts based on estimates of future costs,
      duration of the project, and the impact of potential changes in the scope of
      the
      work. We also enter into other types of contracts, including annual maintenance
      contracts, license agreements, and arrangements on a time and materials
      basis.




Our
      customer, SDC Udvikling A/S, accounted for 12% and 11% of our revenues in 2007
      and 2006, respectively. TEMENOS Group accounted for less than 10% of our
      revenues in 2007 and for 15% of our revenues in 2006. EDS accounted for 11%
      of
      our revenues in 2007 and for less than 10% of our revenues in 2006.




The
      following table summarizes the revenues from our tools and services by
      geographic regions based on the location of the end customer for the periods
      indicated:




**Year
                  ended December 31,****2007**
              
              **2006**
              
              **2005****(in
                  thousands)**USA
              
              $
              23,392
              
              $
              15,048
              
              $
              17,423Europe
                  (other than Denmark)
              
              
              33,349
              
              
              28,449
              
              
              18,643Denmark
              
              
              15,750
              
              
              10,304
              
              
              12,334Israel
              
              
              7,820
              
              
              10,156
              
              
              7,991Other
              
              
              8,087
              
              
              4,047
              
              
              2,556$
              88,398
              
              $
              68,004
              
              $
              58,947


29




***Research
      and Development***





In
      order
      to maintain our position as a market leader in the IT modernization market,
      we
      are focusing our development efforts on further enhancements to current
      solutions, as well as addressing newly emerging aspects of the modernization
      market. We are planning additional research and development activities to extend
      our modernization solutions by leveraging our technological skills to create
      added value for our customers and to generate additional business
      opportunities.





The
      next
      generation of our solutions will be extended to address the entire modernization
      process from legacy systems to modern platforms. We have started to develop
      our
      next generation of products and tools, which will allow the fluent
      transformation of legacy code to state-of-the-art platforms. The new generation
      of solutions is composed of products and tools in several EIM
      categories.





*Enterprise
      IT Understanding*





*BluePhoenixTM
      IT Discovery—* By
      further refining our existing understanding technology and combining it with
      the
      additional technology licensed from Merrill Lynch, IT Discovery will
      provide the basis for legacy understanding needed by the rest of our
      modernization solutions.





*Enterprise
      IT Automated Migration*





*Fourth
      Generation Language Migration* —In
      the
      area of automated migration, we continue to build on our 4GL migration
      solutions. Our assets in the migration area cover COOL:Gen, Mantis, ADSO/IDMS,
      Natural, CSP, and PowerBuilder transformations. We continue to extend the
      support target platform of these transformations to include J2EE and .NET
      platforms.




*Enterprise
      IT SOA Ready Solution* —A
      comprehensive solution that provides Web services or clients for a legacy
      application. Our unique suite of tools enables a legacy application to be
      exposed to more modern applications written in Java or .NET by providing a
      web
      service interface for the legacy system. In addition, our tools are able to
      provide a web based appearance/connectivity/interface legacy applications.
      This
      solution is not intrusive and allows the legacy application to remain
      untouched.





*BluePhoenixTM
      LogicMiner—* A
      comprehensive solution for recovery that mines COBOL and extracts business
      rules
      from the legacy code, thus providing IT departments with the ability to begin
      a
      modernization process based on techniques that preserve the functionality of
      a
      legacy code. This tool retains past investments in software assets by producing
      reusable code objects or descriptive data that can later be used for improving
      the quality of the legacy code, rewriting the legacy application, or building
      a
      full modernization plan. *LogicMiner* increases a system’s manageability, while eliminating rules that no longer apply
      to current business procedures.




30




*BluePhoenixTM
      Refactoring Repository* —A
      repository that supports the storage and management of the abstract models
      and
      code of applications that make use of multiple development architectures such
      as
      legacy information engineering and more modern object oriented and service
      oriented architectures.





*BluePhoenixTM*  *Redevelopment* —A
      solution that provides the ability to generate from the abstract platform
      independent model stored in the *Refactoring
      Repository* to
      platform specific models such as J2EE and .NET. To address this, we are
      extending robust generation technologies to generate platform specifics for
      object orientation and SOA. This model driven modernization environment can
      be
      used to gradually migrate applications rather than requiring an “all at once”
approach. In order to address refactoring, which involves changing from one
      application model to another, we are adding the necessary tools to assist in
      the
      process of taking the information from legacy applications’ architectures via *LogicMiner* to more
      modern architectures such as object and SOA.





*ASNA
      Monarch TM* —
This
      product is used for *understanding* and *migration* of
      AS/400 applications. It ** transforms
      applications originally written in RPG/400 into native and fully compliant
      Microsoft.NET®. It can also migrate the originating database to SQL Server, thus
      providing for a full re-platforming solution. In 2008, we intend to provide
      the
      full support for converting AS/400 applications to C# which is the premier
      development language under the Microsoft .NET environment. This will complete
      our offering and allow the AS/400 community a choice whether to use
      our *ASNA
      Visual RPG® (AVR)* or C#.





*ASNA
      Visual RPG® (AVR)* is a
      modern implementation of RPG that enables RPG developers to easily build Web
      and
      Windows applications.  AVR provides direct, secure and fast access to both
      files and program objects on IBM's System i (formerly known as
      iSeries, AS/400) server. Using a familiar, but modernized syntax, RPG
      programmers can quickly apply their long-standing RPG experience to create
      modern applications that connect seamlessly to the System i (iSeries, AS/400)
      platform.




*AVR
      for .NET* provides
      similar functionalities under Microsoft's .NET Framework.  It enables
      modernizing existing RPG applications, develop Web services, and extend System
      i
      applications to .NET and the inherent support in Service Oriented Architecture
      while continuing to program with a familiar, RPG-like syntax. AVR for .NET
      is the only development solution available for Microsoft's .NET that
      specifically supports high performance access to the System
      i database. In 2008, we intend to extend the functionality of AVR in order
      to make it a more attractive development environment that will be a preferred
      choice for AS/400 installations.





*ASNA
      DataGate®* — *ASNA
      DataGate* provides
      fast and secure iSeries-400 database access. Applications written to access
      the
      iSeries through *DataGate* can
      later
      be connected to SQL Server without modification. A single application may
      connect to both platforms concurrently, or an application may switch,
      automatically, from one platform to the other in the case of a failover
      situation. In 2008, we intend to invest in research and development activities
      aimed to understand the feasibility of providing support for more modern RDBMSs
      such as ORACLE and UDB.




31





*Costs
      and Grants*





Royalty-bearing
      grants from the Government of Israel and other governmental institutions for
      funding approved research and development projects are recognized at the time
      we
      are entitled to such grants. Such grants are included as a deduction of research
      and development costs. Grants received in 2007, 2006 and 2005 amounted to
      $420,000, $417,000 and $319,000, respectively. We are committed to pay royalties
      related to grants from the Government of Israel on sales with regard to the
      funded products of approximately 3% of the generated revenues from such
      products. These royalties are recognized as incurred as costs of revenues.





*Chief
      Scientist Grants*





*Visual
      MainWin® for J2EE Platform* —Through
      December 31, 2007, our subsidiary, Mainsoft, received an aggregate of
      approximately $2.3 million in grants from the Office of the Chief Scientist,
      or
      the OCS, for the development of Visual MainWin® for J2EE. Royalties of 3% are
      payable to the OCS on sales of Visual MainWin® for J2EE, up to 100% of the
      dollar-linked grant received in respect of the funded product. To date, Mainsoft
      has paid the royalties to the OCS as required.





*PowerText* —As
      of
      January 1, 2004, we received through our wholly owned subsidiary, an aggregate
      of approximately $200,000 in grants from the OCS for the development of
      PowerText. PowerText is a software solution for automated electronic document
      mining, management and presentment. Royalties of 3% are payable to the OCS
      on
      all sales of PowerText up to 100% of the dollar-linked grant received.





*BluePhoenixTM
      SOA - Ready Enablement* —Through
      December 31, 2004, our subsidiary, MultiConn Technologies, accrued an aggregate
      of approximately $580,000 in grants from the OCS, for the development of
      BluePhoenixTM SOA - Ready Enablement. Royalties of 3% are payable to the OCS on
      sales of BluePhoenixTM SOA - Ready Enablement up to 100% of the dollar-linked
      grant received in respect of the funded product.





The
      balance of the contingent liability relating to the royalties payable by our
      subsidiaries to the OCS, at December 31, 2007, amounted to approximately $3.1
      million of which $ 2.1 million represents Mainsoft’s contingent liability to the
      OCS.





*Other
      Grants*





In
      the
      first quarter of 2004, the Singapore-Israel Industrial Research and Development
      Foundation agreed to provide one of our wholly owned subsidiaries together
      with
      a company incorporated in Singapore, financing for the development of a Java
      report generator based on legacy text file input. Accordingly, the foundation
      agreed to award our subsidiary up to $100,000 payable according to an agreed
      upon schedule. As of March 26, 2008, we received $45,000 of the grant. The
      grant
      is required to be repaid in installments based on sales of the funded product
      up
      to the amount of the grant.




32





In
      July
      2007, our subsidiary, I-Ter, received final approval from the Ministry of
      Production in Italy for its Easy4Plan product. Easy4Plan is a workflow
      management tool designed for ISO9000 companies. The total funds amounted to
      approximately $650,000, of which 30% constitute a grant, and the balance is
      an
      8-year loan to be repaid by I-Ter. The loan bears a minimal annual interest.
      90%
      of the funds were received in December 2007. The remaining 10% is expected
      to be
      received during 2008 after a review of the Ministry of Production in
      Italy.




***Intellectual
      Property***




We
      rely
      on a combination of trade secret, copyright, and trademark laws and
      nondisclosure agreements, to protect our proprietary know-how. Our proprietary
      technology incorporates processes, methods, algorithms, and software that we
      believe are not easily copied. Despite these precautions, it may be possible
      for
      unauthorized third parties to copy aspects of our products or to obtain and
      use
      information that we regard as proprietary. However, we believe that with regard
      to most of our solutions, because of the rapid pace of technological change
      in
      the industry, patent and copyright protection are less significant to our
      competitive position than factors such as the knowledge, ability, and experience
      of our personnel, new product development, and ongoing product maintenance
      and
      support.




**Competition**




The
      modernization market in which we operate is highly competitive. The principal
      competitive factors affecting the market for our modernization solutions
      include:




· product
      functionality, performance, and reliability;


· technical
      range of the offered solutions;


· integration
      between the offered solutions;


· availability
      of experienced personnel and its expertise;


· prices;


· ability
      to respond in a timely manner to changing customer needs; and


· quality
      of support and vertical market expertise.




Competition
      in the enterprise IT modernization field is, to a large extent, based upon
      the
      functionality of the available tools and personnel expertise. Vendors in this
      market address the modernization of legacy systems in different ways, and
      therefore do not always compete directly with the others. Many small vendors
      address only a small part of the market, providing IT specific solutions. Only
      a
      few vendors offer comprehensive and integrated tools and solutions that can
      respond to the most challenging modernization issues that companies are facing.
      Some large vendors, such as Oracle, HP and Intel have joined forces to lead
      the
      market in an organized mainframe modernization initiative, the Application
      Modernization Initiative (AMI). These three vendors also intend to create a
      selected consortium of vendors in order to broaden the depth and breadth of
      their migration offering ***.***




Our
      principal competitors consist of system integrators, offshore outsourcers,
      and
      tool vendors, including leading
      software developers ,
      who
      enable the replacement or modernization of legacy systems.




33




Major
      system integrators in the market include IBM, Accenture, Capgemini, and EDS.
      IBM
      has established legacy modernization as a strategic aspect of its long-term
      application development strategy. Major system integrators have a specific
      and
      dominant advantage in the underlying application development infrastructure
      associated with many legacy environments (predominantly IBM mainframes) and
      a
      large service delivery capability. In some cases, we cooperate with some of
      these system integrators in providing specific solutions or
      portions of comprehensive projects. Major offshore outsourcers in the market
      include TCS (Tata Consulting Services), WIPRO, Patni, and Infosys. Both systems
      integrators and
      offshore outsourcers have vertical market groups offering consulting and
      professional services.




We
      also
      face competition from niche tools and solutions companies operating in each
      of
      the four principal areas of the enterprise IT
      modernization  market :





· Enterprise
      IT Understanding;


· Enterprise
      IT Migration;


· Enterprise
      IT Remediation; and


· Enterprise
      IT Redevelopment.





For
      example, Cast Application Intelligence Platform reads application source code
      to
      analyze the fine-grained relationships among software artifacts - objects,
      functions, stored procedures, database tables and columns, scripts and
      others.  MetaWare
      provides services and products such as re-hosting, database and programming
      language conversions. Most software technologies address the ADABAS/Natural
      arena, and other competitors focus on collecting sufficient information about
      application portfolios to improve business processes. Other solution developers
      provide distributed repository solutions and architecture modernization
      services.




**C.**  **Organizational
      Structure**




We
      run
      our worldwide operations through several wholly owned and controlled
      subsidiaries, named below:





**Name
                of Subsidiary**
            
            **Country
                of Incorporation**BluePhoenix
                Solutions USA Inc.
            
            United
                StatesAmalgamated
                Software NA Inc. (ASNA)
            
            United
                StatesBridgeQuest
                Inc.
            
            United
                StatesBluePhoenix
                Solutions Nordic ApS
            
            DenmarkBluePhoenix
                Solutions U.K. Ltd.
            
            United
                KingdomBluePhoenix
                Solutions Srl.
            
            ItalyI-Ter/Informatica
                & Territorio S.p.A.
            
            ItalyBluePhoenix
                Solutions GmbH
            
            GermanyBluePhoenix
                Solutions B.V.
            
            The
                NetherlandsBluePhoenix
                Solutions Ltd.
            
            CyprusBluePhoenix
                Solutions Srl.
            
            RomaniaBluePhoenix
                Solutions Co., Ltd.
            
            KoreaLiacom
                Systems Ltd.
            
            IsraelZulu
                Software Inc.
            
            United
                StatesMainsoft
                Corporation
            
            United
                States




34




**D.**  **Property,
      Plants and Equipment** ****





We,
      together with our subsidiaries and affiliates, currently occupy approximately
      11,300 square meters of office space. The aggregate annual rent we paid for
      these facilities in 2007 was $2.5 million. The following table presents certain
      information about our facilities and the terms of lease of these
      facilities.





**Country
                and State**
            
            **City**
            
            **Sq.**
              **Meters**
            
            **Expiration**
            
            **Annual**
              **anticipated**
              **rental
                fees in**
              **2008****(*)**
              **in
                thousands $**Israel
            
            Herzliya
            
            2,170
            
            December
                2008
            
            258Israel
            
            Holon
            
            280
            
            August
                2008
            
            25Israel
            
            Lod
            
            1,076
            
            June
                2008
            
            157USA,
                North Carolina
            
            Cary
            
            700
            
            April
                2012
            
            147USA,
                California
            
            Santa
                Clara
            
            160
            
            October
                2008
            
            18USA,
                Texas
            
            San
                Antonio
            
            1,386
            
            July
                2010
            
            284Denmark
            
            Ballerup
            
            2,074
            
            November
                2008
            
            429Germany
            
            Frankfurt
            
            115
            
            August
                2008
            
            36Romania
            
            Bucharest
            
            900
            
            October
                2011
            
            235United
                Kingdom
            
            Milton
                Keynes
            
            180
            
            November
                2012
            
            46United
                Kingdom
            
            Surrey
            
            125
            
            September
                2011
            
            75Cyprus
            
            Nicosia
            
            517
            
            June
                2009
            
            85Italy
            
            Milan
            
            150
            
            April
                2012
            
            44Italy
            
            Riccione
            
            220
            
            January
                2014
            
            31Italy
            
            Milan
            
            110
            
            April
                2012
            
            14Italy
            
            Roma
            
            124
            
            May
                2012
            
            36Russia
            
            St.
                Petersburg
            
            1,010
            
            December
                2009
            
            564**Total**
            
            
            
            **11,297**
            
            
            
            **2,484**





(*) Includes
      related fees such as management fees, maintenance, parking etc.





If,
      in
      the future, we determine that we need additional space to accommodate our
      growth, we believe that we will be able to obtain this additional space without
      difficulty and at commercially reasonable prices. We do not own any real
      property.




35




**ITEM
      4A. UNRESOLVED STAFF COMMENTS**





None.





**ITEM
      5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS**




**Overview**





We
      have
      been pursuing a strategy of adding new technologies to our suite of automated
      modernization tools. As a result, our revenues increased from $58.9 million
      in
      2005 to $68.0 million in 2006 and to $88.4 million in 2007.





We
      enhanced our solutions and services portfolio via internal development of new
      software tools and through acquisitions and investments. Accordingly, we devote
      significant resources to the development and marketing of new software
      modernization tools. In addition, we invest in businesses that develop software
      tools that are complementary to our existing portfolio and invest in a skilled
      and specialized workforce.





In
      August
      2007, we acquired Amalgamated Software North America (ASNA). ASNA’s product,
      Monarch, is a fully integrated solution for transforming RPG applications to
      the
      Microsoft .NET platform. ASNA is a Microsoft Gold Certified Partner, a Microsoft
      Visual Studio Industry Partner, an IBM Tools Network Partner, and an Advanced
      Tier Member of IBM’s PartnerWorld for Developers. We expect to expand our
      modernization offering to enterprises running legacy applications on the IBM
      AS/400, iSeries, and System i who are facing the mounting challenge of
      modernizing their RPG-based applications, by providing these enterprises both
      software tools and services required to perform these tasks
      successfully.





In
      April
      2007, we acquired
      BridgeQuest Inc., a North Carolina corporation that manages and operates,
      through a wholly owned subsidiary, a professional outsourcing center in St.
      Petersburg, Russia. This
      alternative large offshore center in St. Petersburg, Russia offers services
      at a
      lower cost than our other offshore
      facilities in Romania and Cyprus .
      St.
      Petersburg is also close to our European customers, and therefore can provide
      easy access for customers who may be interested in post-modernization services
      that will be provided from a near, although off-shore, location. We anticipate
      that this strategic acquisition will enable us to increase our
      profitability.





In
      January 2008, we announced our decision to sell our holdings in our subsidiary
      Mainsoft, in which we hold a 58% controlling interest. Our management’s decision
      followed a strategic shift in Mainsoft's product development and marketing
      strategy outside of BluePhoenix's core business focus. Based on the impairment
      tests performed in the fourth quarter of 2007, an impairments loss of $7 million
      related to goodwill in Mainsoft has been identified and was charged to income.
      As a result, we recorded a one-time, non-cash, charge of $7 million as
      impairment of goodwill and had a net loss of $8.2 million in 2007 compared
      to
      net income of $4.7 million generated in 2006 and $1.8 million in 2005.




36





Economic
      changes such as the U.S. subprime mortgage loan crisis and the economic
      instability caused by the rise in oil prices, are affecting companies’
willingness, in both the U.S. and in Europe, to make capital spending on IT
      projects. We cannot know whether IT capital spending and investment in IT
      projects will continue in the future at the same level, or how the economic
      conditions will affect our business. Accordingly, we cannot assure you that
      we
      will be able to increase our revenues or keep our revenues at the same level
      as
      in 2007. As we continue to market new products and penetrate international
      markets, we expect our selling, general and administrative expenses to continue
      to be relatively high





****** Our
      quarterly and annual results of operations have fluctuated significantly in
      the
      past and we expect them to continue to fluctuate significantly in the future,
      as
      a result of numerous factors, including the changes in the suite of
      modernization tools we have been offering to our customers, the impact of
      acquisitions and dispositions of companies, and the difficulties we have
      encountered in introducing our tools to the market. Therefore, we believe that
      period-to-period comparisons of our financial results are not necessarily
      meaningful and you should not rely on them as an indication of future
      performance.




***Challenges
      and Opportunities***





While
      there are many opportunities to be targeted in today’s modernization market,
      delivering constant growth in revenues while maintaining and improving gross
      profits is an ongoing challenge. Although the increasing need for IT legacy
      modernization points to an increasing market, there are no guarantees that
      the
      increasing need will be followed by an increasing demand for our technology
      as a
      result of global economic changes, and that we will be able to maintain our
      current growth rate.





The
      technology used for modernization projects changes on an ongoing basis in line
      with the underlying legacy technology and systems. In order to maximize the
      opportunities at hand, we must continue to be successful at identifying market
      trends and predicting the need for new tools and modernization services in
      the
      various areas of enterprise technology.





Our
      opportunity for growth and our operational strategy is partially based on the
      acquisition of companies with services, tools, and technologies that extend
      or
      complement our existing business. We may face increased competition for
      acquisition opportunities or difficulties in identifying and locating new tools
      and technologies, which may inhibit our ability to complete suitable
      acquisitions on favorable terms. Successful integration of acquired
      technologies, service centers, or companies into our existing business and
      suite
      of solutions will remain a significant challenge for us.





In
      2007,
      we continued to expand our operations into new potential markets such as in
      the
      Asia  Pacific
      region where we opened a new office in Korea, and in Europe, where we are
      expanding into countries like France where we have had only a limited presence
      to date. While there are excellent opportunities for growth in these areas,
      the
      successful penetration to new markets and environments remains a sales and
      management challenge.




37





To
      keep
      up with the growing number of projects we have successfully secured, we must
      recruit and retain additional personnel who are highly skilled in the fields
      of
      project management, legacy systems, and leading modern technologies. However,
      the number of skilled personnel is limited and the competition for attracting
      and retaining such personnel is intense, particularly in the information
      technology industry.




***Consolidation
      of the Results of Operations of Our Subsidiaries***





Following
      is information regarding the consolidation of the results of operations of
      certain of our subsidiaries, for the periods indicated. We began to consolidate
      the results of operations of each of these subsidiaries when we acquired control
      in them.





Name
                of Subsidiary
            
            Beginning
                ConsolidationZulu
                Software Inc.
            
            First
                quarter of 2006BridgeQuest
                Inc.
            
            Second
                quarter of 2007ASNA
            
            Third
                quarter of 2007




***Critical
      Accounting Policies***





We
      prepare our consolidated financial statements in conformity with U.S. GAAP.
      Accordingly, we are required to make certain estimates, judgments, and
      assumptions that we believe are reasonable based upon the information available.
      These estimates and assumptions affect the reported amounts of assets and
      liabilities at the date of the financial statements and the reported amounts
      of
      revenues and expenses during the periods presented. The significant accounting
      policies that we believe are the most critical to aid in fully understanding
      and
      evaluating our reported financial results include the following:





***Revenue
      recognition.*** ** Our
      revenue recognition policy is significant because our revenue is a key component
      of our results of operations. We follow specific and detailed guidelines in
      measuring revenue; however, certain judgments affect the application of our
      revenue policy. Revenue results are difficult to predict and any shortfall
      in
      revenue or delay in recognizing revenue could cause our operating results to
      vary significantly from quarter to quarter and could result in future operating
      losses. Should changes in conditions cause management to determine that these
      guidelines are not met for certain future transactions, revenue recognized
      for
      any reporting period could be adversely affected.





Revenues
      derived from direct software license agreements are recognized in accordance
      with Statement of Position (SOP) 97-2 “Software Revenue Recognition” (as amended
      by SOP 98-4 and SOP 98-9), upon delivery of the software, when collection is
      probable, the license fee is otherwise fixed or determinable, and persuasive
      evidence of an arrangement exists. There are no rights to return products or
      similar contingencies in our contracts.





We
      typically sell our software products and services in stand-alone contracts
      for
      software product licenses, services, or Post Contract Support, referred to
      as
      PCS. A relatively small portion of our arrangements includes multiple elements.
      These arrangements are usually arrangements in which we sell a software product
      license and PCS.




38





We
      follow
      paragraph 10 of SOP 97-2, “Software Revenue Recognition,” as amended, and
      allocate the total fee arrangement to the software and the PCS undelivered
      element based on vendor-specific objective evidence, referred to as VSOE. We
      allocate the total fee arrangement based on the guidance set forth in paragraph
      57 of SOP 97-2, which states, “The fair value of the PCS should be determined by
      reference to the price the customer will be required to pay when it is sold
      separately.”





We
      calculate the fair value of PCS in two different manners, depending on the
      circumstances. Fair value is based on either (i) the consistent renewal rate
      of
      the PCS stated in the relevant contract, or (ii) the price charged when the
      PCS
      is sold separately. In either case, the portion of the fee arrangement allocated
      to the PCS is recognized as revenues ratably over the term of the PCS
      arrangement.





VSOE
      for
      most of our solutions is determined using the bell-shaped curve approach by
      evaluating the price paid for PCS sold separately. Under this method, VSOE
      of
      fair value is determined by evaluating the price paid for PCS when sold
      separately. We follow the guidance of TPA 5100-55, and accordingly, determine
      the VSOE using that consistent percentage of the stated license fee of the
      respective arrangements.





In
      some
      of the agreements with our customers, the customers have the right to receive
      unspecified upgrades on an if-and-when available basis (we do not provide
      specific upgrades). These upgrades are considered PCS.





Long
      term
      contracts accounted for pursuant to SOP 81-1,“Accounting for Performance of
      Construction-Type Contracts,” are contracts in which we sell our software
      framework, on which material modifications, developments and customizations
      are
      performed, to provide the customer with a new and modern IT application with
      enhanced capabilities that were unavailable in its former legacy system. The
      aforementioned services are essential to the functionality of the software
      and
      to its compliance with customers’ needs and specifications. We account for these
      arrangements pursuant to paragraph 7 to SOP 97-2 and TPA 5100.48.





Under
      this method, estimated revenue is generally accrued based on costs incurred
      to
      date, as a percentage of total updated estimated costs.





We
      recognize contract losses, if any, in the period in which they first become
      evident. Some of our contracts include client acceptance clauses. In these
      contracts, we follow the guidance of TPA 5100.67 and SAB 104. In determining
      whether revenue can be recognized, when an acceptance clause exists, we consider
      our history with similar arrangements, the customer’s involvement in the
      negotiation process, and the existence of other service providers and the
      payment terms.





We
      present revenues from products and revenues from services in separate line
      items. The product revenues line item includes revenues generated from (i)
      stand-alone software products; and (ii) software products that were included
      in
      multiple-element arrangements and were separated pursuant to SOP 97-2 as
      aforementioned.




39





In
      the
      services revenue line item, we included (i) revenues generated from stand-alone
      consulting services; (ii) revenues generated from stand-alone PCS; (iii)
      revenues accounted for pursuant to SOP 81-1; and (iv) revenues generated from
      PCS included in multiple-element arrangement and were separated pursuant to
      SOP
      97-2 as aforementioned. We have included all SOP 81-1 arrangements in the
      service revenues line item since we can not establish VSOE of fair value to
      neither the service element nor the software element. Our software framework
      and
      these kinds of modifications and customizations are not sold separately.
      Therefore, we can not appropriately justify reflecting the product
      portion


separately
      in our statement of operations.





We
      believe that our revenue recognition policies are in accordance with the
      Securities and Exchange Commission Staff Accounting Bulletin No. 101 and
      SAB 104, “Revenue Recognition in Financial Statements.”





***Capitalized
      research and development costs.*** ** Research
      and development costs of software that is intended for sale that were incurred
      after the establishment of technological feasibility of the relevant product,
      are capitalized. Technological feasibility is determined when detailed program
      design is completed and verified in accordance with the provisions of the
      Statement of Financial Accounting Standards No. 86 (SFAS 86). Research and
      development costs incurred before technological feasibility is established
      are
      charged to the statement of operations as incurred, net of participation of
      the
      Office of the Chief Scientist (OCS). Our policy on capitalized research and
      development costs determines the timing of our recognition of certain
      development costs. In addition, this policy determines whether the cost is
      classified as development expense or capitalized costs. Management is required
      to use professional judgment in determining whether development costs meet
      the
      criteria for immediate expense or capitalization. Amortization of capitalized
      research and development costs begins when the product is available for general
      release to customers. Annual amortization is computed by the straight-line
      method, over the remaining useful life of the product, currently over a period
      of 5 years, or based on the ratio of current gross revenues to current and
      anticipated future gross revenues, whichever is higher. Our failure to
      accurately predict the useful life of capitalized research and development
      costs
      could cause a one-time amortization, which could adversely affect our operating
      results.





***Impairment
      of goodwill and intangible assets.*** Our
      business acquisitions resulted in goodwill and other intangible assets. We
      periodically evaluate our goodwill, intangible assets, and investments in
      affiliates for potential impairment indicators. Our judgments regarding the
      existence of impairment indicators are based on legal factors, market
      conditions, and operational performance of our acquired businesses and
      investments.





In
      accordance with FASB Statement of Financial Accounting Standards No. 142
“Goodwill and Other intangible Assets” (SFAS 142), indefinite life intangible
      assets and goodwill are not amortized but rather subject to annual impairment
      testing.





Goodwill
      and intangible assets are tested for impairment by comparing the fair value
      of
      the reporting unit with its carrying value. Fair value is generally determined
      using discounted cash flows, market multiples, and market capitalization.
      Significant estimates used in the fair value methodologies include estimates
      of
      future cash flows, future short-term and long-term growth rates, weighted
      average cost of capital and estimates of market multiples of the reportable
      unit. If these estimates or their related assumptions change in the future,
      we
      may be required to record impairment charges for our goodwill and intangible
      assets. These write downs may have an adverse affect on our operating results.
      Future events could cause us to conclude that impairment indicators exist and
      that additional intangible assets associated with our acquired businesses are
      impaired.




40





The
      process of evaluating the potential impairment of goodwill is subjective and
      requires significant judgment at many points during the analysis. In estimating
      the fair value of the reporting unit for the purpose of our annual or periodic
      analysis, we make estimates and judgments about the future cash flows of that
      reporting unit. Although our cash flow forecasts are based on assumptions that
      are consistent with our plans and estimates we are using to manage the
      underlying businesses, there is significant exercise of judgment involved in
      determining the cash flows attributable to a reporting unit over its estimated
      remaining useful life. In addition, we make certain judgments about allocating
      shared assets to the estimated balance sheets of our reporting units. Changes
      in
      judgment on these assumptions and estimates could result in a goodwill
      impairment charge. Any resulting impairment loss could have a material adverse
      impact on our financial condition and results of operations.





Our
      intangible assets are tested for impairment on a regular basis, and written
      down
      when impaired. Pursuant to impairment tests performed in the fourth quarter
      of
      2007, an impairment loss of $7 million related to goodwill in Mainsoft, has
      been
      identified and was charged to income. Mainsoft, in which we hold 58% of its
      outstanding share capital, was acquired in a series of transactions between
      the
      years 1999 to 2001.  There
      can
      be no assurance that future goodwill impairment tests or the consideration
      that
      will result from the intended sale of Mainsoft, if it occurs, will not result
      in
      additional charges to earnings.





***SFAS
      123(R).*** On
      January 1, 2006, we adopted Statement of Financial Accounting Standards No.
      123
      (revised 2004), “Share-Based Payment,” referred to as SFAS 123(R), which
      requires the measurement and recognition of compensation expense based on
      estimated fair values for all share-based payment awards made to employees
      and
      directors. SFAS 123(R) requires companies to estimate the fair value of
      equity-based payment awards on the date of grant using an option-pricing model.
      The value of the portion of the award that is ultimately expected to vest is
      recognized as an expense over the requisite service periods in our consolidated
      income statement. Prior to the adoption of SFAS 123(R), we accounted for
      equity-based awards to employees and directors using the intrinsic value method
      in accordance with APB 25 as allowed under Statement of Financial Accounting
      Standards No. 123, “Accounting for Stock-Based Compensation,” or SFAS 123. Our
      determination of fair value of share-based payment awards on the date of grant
      using an option-pricing model is affected by our share price as well as
      assumptions regarding a number of highly complex and subjective variables.
      These
      variables include, but are not limited to our expected share price volatility
      over the terms of the awards, and actual and projected employee share option
      exercise behaviors. Although the fair value of employee share options is
      determined in accordance with SFAS 123(R) and SAB 107 using an option-pricing
      model, that value may not be indicative of the fair value observed in a willing
      buyer/willing seller market transaction. As
      of
      December 31, 2007 onward, we adopted SAB 110 in developing an estimate of the
      expected term.




41





***Income
      taxes.***  In
      July
      2006, the Financial Accounting Standards Board, or FASB, issued Interpretation
      No. 48, Accounting for Uncertainty in Income Taxes — An Interpretation
      of FASB Statement No. 109, or FIN 48, which requires income tax
      positions to meet a more-likely-than-not recognition threshold to be recognized
      in the financial statements. Under FIN 48, tax positions that previously
      failed to meet the more-likely-than-not threshold should be recognized in the
      first subsequent financial reporting period in which that threshold is met.
      Previously recognized tax positions that no longer meet the more-likely-than-not
      threshold should be derecognized in the first subsequent financial reporting
      period in which that threshold is no longer met. Prior to 2007, we recorded
      estimated income tax liabilities to the extent they were probable and could
      be
      reasonably estimated. As a multinational corporation, we are subject to taxation
      in many jurisdictions, and the calculation of our tax liabilities involves
      dealing with uncertainties in the application of complex tax laws and
      regulations in various taxing jurisdictions. If we ultimately determine that
      the
      payment of these liabilities will be unnecessary, we reverse the liability
      and
      recognize a tax benefit during the period in which we determine the liability
      no
      longer applies. Conversely, we record additional tax charges in a period in
      which we determine that a recorded tax liability is less than we expect the
      ultimate assessment to be. The application of tax laws and regulations is
      subject to legal and factual interpretation, judgment and uncertainty. Tax
      laws
      and regulations themselves are subject to change as a result of changes in
      fiscal policy, changes in legislation, the evolution of regulations and court
      rulings. Therefore, the actual liability for Israeli or foreign taxes may be
      materially different from our estimates, which could result in the need to
      record additional tax liabilities or potentially reverse previously recorded
      tax
      liabilities. The adoption of FIN 48 did not result in a change to our retained earning.
      As of December 31, 2007, there are no unrecognized tax benefits.




***Accounts
      receivable and Allowances for Doubtful Accounts.*** Our
      trade receivables includ e
      amounts
      due from customers. We perform ongoing credit evaluations of our customers’
financial condition and we require collateral as deemed necessary. We maintain
      allowances for doubtful accounts for estimated losses resulting from the
      inability of our customers to make payments. In judging the adequacy of the
      allowance for doubtful accounts, we consider multiple factors including the
      aging of our receivables, historical bad debt experience and the general
      economic environment. Management applies considerable judgment in assessing
      the
      realization of receivables, including assessing the probability of collection
      and the current credit worthiness of each customer. If the financial condition
      of our customers were to deteriorate, resulting in an impairment of their
      ability to make payments, additional allowances may be required.




***Derivative
      Instruments*** **.** We have
      adopted Statement of Financial Accounting Standards SFAS No. 133 “Accounting for
      Derivative Instruments and Hedging Activities”, referred to as SFAS 133. Under
      the provisions of SFAS 133, all derivatives are recognized on the balance sheet
      at their fair value. Changes in fair value are recognized periodically in
      earnings or accumulated other comprehensive income within shareholders’ equity,
      depending on the intended use of the derivative and whether the derivative
      has
      been designated by management as a hedging instrument. Changes in fair value
      of
      derivative instruments not designated as hedging instruments are recognized
      in
      earnings in the current period.




We
      use
      foreign currency options, forward exchange contracts and forward interest
      contracts to assist in managing financial risks. We do not use derivative
      financial instruments for speculative purposes. These instruments are recognized
      at fair value, with all changes in fair value recorded in current period
      earnings, as these transactions have not been designated as hedging instruments
      under SFAS 133.




42




In
      2007,
      we had convertible notes, which contained an embedded put option that was
      bifurcated from the host debt and was being recorded at fair value in accordance
      with SFAS 133.




***Recently
      Issued Accounting Pronouncements***





In
      September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements," or
      SFAS
      157. This standard defines fair value, establishes a framework for measuring
      fair value in generally accepted accounting principles and expands disclosures
      about fair value measurements. The provisions of SFAS 157 are effective for
      us
      beginning January 1, 2008. The FASB issues a FASB Staff Position (FSP) to defer
      the effective date of SFAS 157 for one year for all non-financial assets and
      non-financial liabilities, except for those items that are recognized or
      disclosed at fair value in the financial statements on a recurring basis. We
      do
      not expect the adoption will have material impact on our consolidated financial
      statements.




In
      February 2007, the FASB issued FAS 159, “The Fair Value Option for Financial
      Assets and Financial Liabilities.” This standard permits entities to choose to
      measure many financial assets and financial liabilities at fair value.
      Unrealized gains and losses on items for which the fair value option has been
      elected are reported in earnings. As applicable to us, this statement will
      be
      effective as of the year beginning January 1, 2008. We do not expect the
      adoption of FAS 159 to have a material impact on our consolidated financial
      statements.




In
      December 2007, the FASB issued SFAS No. 141(R), “Business Combinations,” or SFAS
      141(R). SFAS 141(R) establishes principles and requirements for how an acquirer
      recognizes and measures in its financial statements the identifiable assets
      acquired, the liabilities assumed, the goodwill acquired, and any noncontrolling
      interest in the acquire. This statement also establishes disclosure requirements
      to enable the evaluation of the nature and financial effect of the business
      combination. SFAS 141(R) is effective for fiscal years beginning after December
      15, 2008. Earlier adoption is prohibited. We are currently evaluating the
      potential impact, if any, of the adoption of FAS 141(R) on our consolidated
      financial statements.




In
      December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
      Consolidated Financial Statements - an amendment of ARB No. 51,” or SFAS 160.
      SFAS 160 establishes accounting and reporting standards pertaining to ownership
      interests in subsidiaries held by parties other than the parent, the amount
      of
      net income attributable to the parent and to the noncontrolling interest,
      changes in a parent’s ownership interest, and the valuation of any retained
      noncontrolling equity investment when a subsidiary is deconsolidated. This
      statement also establishes disclosure requirements that clearly identify and
      distinguish between the interests of the parent and the interests of the
      noncontrolling owners. SFAS 160 is effective for fiscal years beginning on
      or
      after December 15, 2008.




In
      December 2007, the SEC issued Staff Accounting Bulleting No. 110, or SAB 110,
      relating to the use of a "simplified" method in developing an estimate of the
      expected term of "plan vanilla" share options. SAB 107 previously allowed the
      use of the simplified method until December 31, 2007. SAB 110 allows, under
      certain circumstances, to continue to accept the use of the simplified method
      beyond December 31, 2007. The adoption of SAB 110 will impact our consolidated
      financial statements since we use the "simplified" method in developing an
      estimate of the expected term on our share options.




43





***Our
      Reporting Currency***





The
      currency of the primary economic environment in which the operations of
      BluePhoenix and most of its subsidiaries are conducted is the U.S. dollar.
      In
      addition, a substantial portion of our revenues and costs are incurred in
      dollars. Thus, the dollar is our functional and reporting currency.





We
      follow
      SFAS 52 “Foreign Currency Translation” and accordingly non monetary transactions
      denominated in currencies other than the dollar are measured and recorded in
      dollar at the exchange rates prevailing at transaction date. Monetary assets
      and
      liabilities denominated in currencies other than the dollar are translated
      at
      the exchange rate on the balance sheet date. Exchange gain or losses on foreign
      currency translation are recorded in income.





Following
      is a summary of the most relevant monetary indicators for the reported
      periods:





**For
                the year ended**
              **December
                31,**
            **Inflation
                rate in Israel**
            **Devaluation
                of NIS**
              **against
                the US$**
            **Devaluation
                of euro**
              **against
                the US$****%**
            **%**
            **%**2005
            2.4
            6.8
            13.32006
            (0.1)
            (8.2)
            (11.3)2007
            3.4
            (8.7)
            (11.7)




**A.**  **Operating
      Results** ****





The
      following table presents the percentage relationships of certain items from
      our
      consolidated statement of operations, as a percentage of total revenues for
      the
      periods indicated:





**Statement
      of Operations Data as a Percentage of Revenues:**




**Year
                  ended December 31,****2007**
              
              **2006**
              
              **2005**%
              
              %
              
              %Revenues
              
              
              100.0
              
              
              100.0
              
              
              100.0Cost
                  of revenues
              
              
              43.7
              
              
              41.9
              
              
              43.1Gross
                  profit
              
              
              56.3
              
              
              58.1
              
              
              56.9Research
                  and development costs
              
              
              16.0
              
              
              13.8
              
              
              13.6Selling,
                  general, and administrative expenses
              
              
              37.1
              
              
              32.6
              
              
              36.7Goodwill
                  impairment
              
              
              7.9
              
              
              -
              
              
              -Restructuring
                  costs
              
              
              0.8
              
              
              -
              
              
              -Operating
                  income (loss)
              
              
              (5.5)
              
              
              11.7
              
              
              6.6Financial
                  expenses, net
              
              
              (4.9)
              
              
              (5.2)
              
              
              (3.3)Other
                  income, net
              
              
              1.0
              
              
              0.4
              
              
              0.2Income
                  (loss) before taxes on income
              
              
              (9.4)
              
              
              6.9
              
              
              3.5Income
                  tax expense (income), net
              
              
              0.1
              
              
              (0.4)
              
              
              0.3(9.5)
              
              
              7.3
              
              
              3.2Minority
                  interest
              
              
              0.2
              
              
              (0.4)
              
              
              (0.2)Equity
                  in earnings of affiliated companies, net
              
              
              -
              
              
              -
              
              
              -Net
                  income (loss)
              
              
              (9.3)
              
              
              6.9
              
              
              3.0




44





**Years
      Ended December 31, 2007 and 2006**





*Revenues.* Revenues
      increased 30% from $68.0 million in 2006 to $88.4 million in 2007.




Revenues
      generated from products grew 100% from $10.1 million in 2006 to $20.4 million
      in
      2007. The increase is attributed the e xpansion
      of our product offering through acquisitions and internal development efforts.
      Tools such as ICL/Migrator, ADABAS/Natural to RDBMS/Java, COBOL LE Enabler,
      PowerBuilder to Java, IMS migration and other were introduced during 2006 and
      2007 and were integrated into our suite of
      solutions. In
      August
      2007 we introduced the Monarch, for transforming RPG applications to
      Microsoft.Net platform.




Revenues
      from professional services grew 17% from $57.9 million in 2006 to $67.9 million
      in 2007. The increase in revenues from professional services is attributed
      to
      the increase in professional services related to our expanded product offerings
      which met the increasing demand for legacy software modernization.




We constantly
      update our suite of solutions in order to support a larger variety of languages,
      databases, and platform conversions. We believe that, as a result, IT service
      companies choose to license our technologies for use in modernization projects
      for their end customers.




In
      2007,
      we continued strengthening our sales team and devoted significant management
      attention to increase market awareness and to establish a strong reputation
      as a
      leader in the modernization market. We have also increased our marketing efforts
      through targeted exhibitions, an expanded public relations program, Web and
      e-mail marketing, online Webcasts, and other lead generation campaigns. These
      have significantly contributed to increasing the interest in our products and
      solutions and have helped to drive the growth in revenues.




The
      table
      below presents the breakdown of our revenues based on the location of our
      customers for the periods indicated:





**2007**
            
            **2006**
            
            **2005**%
            
            %
            
            %United
                States
            
            
            26
            
            
            22
            
            
            30Europe
                (other than Denmark)
            
            
            38
            
            
            42
            
            
            32Denmark
            
            
            18
            
            
            15
            
            
            21Israel
            
            
            9
            
            
            15
            
            
            14Other
            
            
            9
            
            
            6
            
            
            3Total
            
            
            100
            
            
            100
            
            
            100





*Cost
      of revenues.* Cost of
      revenues increased by 36% from $28.5 million in 2006 to $38.7 million in 2007.
      Cost of revenues consists of salaries, travel costs relating to projects and
      services rendered, amortization of capitalized research and development costs,
      and fees paid to independent subcontractors. Cost of revenues in 2007 included
      $982,000 of integration expenses related to our recent acquisitions. Cost of
      revenues as a percentage of revenues increased from 42% in 2006 to 44% in 2007,
      as a result of an increase in amortization of research and development costs
      which increased from $7.1 million in 2006 to $10.5 million in 2007. This
      increase was related to the amortization of capitalized research and development
      costs as a result of general release of developed modernization tools and the
      increase of the amortization of purchased technologies and intangible assets
      related to recent acquisitions *.*




45





*Research
      and development costs.* Research
      and development costs, gross, consist of salaries and consulting fees that
      we
      pay to professionals engaged in the development of new software tools and
      related methodologies. Research and development costs, net, consist of research
      and development costs, gross, less development grants and capitalized research
      and development costs. Our development costs are attributed to the development
      of our modernization suite of tools and are charged to operations as incurred,
      unless capitalized according to SFAS 86.





Research
      and development costs, gross, increased from $17.7 million in 2006 to $19.4
      million in 2007. Research and development costs in 2007 included $183,000
      integration expenses related to our recent acquisitions and additional $500,000
      attributed to the research and development expenses in ASNA that was acquired
      during 2007. The remaining increase is attributed to our increase in effort
      to update
      our suite of solutions in order to support a larger variety of languages,
      databases, and platform conversions.





Research
      and development costs, net, increased from
      $9.4
      million in 2006 to $14.1 million in 2007. As a
      percentage of revenues, research and development costs, net increased from
      14%
      in 2006 to 16% in 2007. The increase, in addition to the aforementioned, is
      as a
      result of the decrease in capitalization. In 2007, we capitalized research
      and
      development costs in an aggregate amount of $5.3 million compared to $8.2
      million in 2006.





*Selling,
      general, and administrative expenses.* Selling,
      general, and administrative expenses consist primarily of wages and related
      expenses, travel expenses, third party and sales commissions, selling expenses,
      marketing and advertising expenses, rent, insurance, utilities, professional
      fees, and depreciation. Selling, general, and administrative expenses increased
      by 48% from $22.1 million in 2006 to $32.8 million in 2007. As a percentage
      of
      revenues, selling, general and administrative expenses increased from 33% in
      2006 to 37% in 2007. The increase is attributed to integration charges in the
      amount of $688,000 incurred as a result of the acquisitions of BridgeQuest
      and
      ASNA. A $1.8 million non-cash charge incurred by us as a result of the payment
      by Formula Systems (1985) Ltd., or Formula, to our CEO of a bonus with
      respect to the sale by Formula of its shareholding in BluePhoenix, was
      also
      charged to selling, general, and administrative expenses. We also incurred
      a
      charge of stock-based non-cash compensation in the amount of $1.0 million
      compared to almost zero in 2006. The remaining increase is attributed to the
      increase of the increase in overall activity of our company.





*Goodwill
      impairment.* Our
      intangible assets are tested for impairment on a regular basis, and written
      down
      when impaired. Pursuant to impairment tests performed in the fourth quarter
      of
      2007, an impairment loss of $7 million related to goodwill in Mainsoft has
      been
      identified and was charged to income. There can be no assurance that future
      goodwill impairment tests or the consideration that will result from the
      intended sale of Mainsoft, if it occurs, will not result in additional charges
      to earnings. The remaining value of goodwill related to Mainsoft is $4.0
      million.




46





*Restructuring
      costs.* In 2007,
      we went through a restructuring process, mainly due to recent acquisitions,
      which was followed by reorganization in our research and development and project
      delivery departments. Total restructuring expenses in 2007 amounted to $694,000
      and consist of severance costs to terminated employees.





*Financial
      expenses, net.* Financial expenses increased from $3.5 million in 2006 to $4.4 million in 2007.
      The increase in financial expenses was mainly attributable to non-cash expenses
      related to the convertible debentures and embedded derivatives which increased
      from $1.2 million in 2006 to $2.1 million in 2007. This increase related to
      the
      conversion of the $3 million and $5 million debentures into equity and as such,
      all unamortized discount and the beneficial conversion features were charged
      to
      financial expenses. Additional financial expenses in 2007 were attributable
      to a
      $10.5 million increase in our overall borrowings from banks which were
      attributed to the acquisitions of BridgeQuest and ASNA. In November 2007, we
      consummated a $35 million private placement, the proceeds of which were mainly
      used to repay all of our bank loans, in the aggregate amount of $32 million.
      We
      expect financial expenses to be reduced significantly following such repayments
      and as a result of the conversion of all our debentures and notes as of December
      31, 2007.





*Other
      income, net.* Other
      income consisted of a $758,000 payment from Cicero Inc., of which $300,000
      was
      in cash and $458,000 was in securities. This amount was previously charged
      to
      provision for losses. The amount was received as part of a settlement pursuant
      to an agreement signed on October 30, 2007 with Cicero, in which we repaid
      $1.7
      million on behalf of Cicero to Bank Ha’Poalim to cover part of Cicero’s credit
      facility with the bank. (For more information see “Item 4.B. Business
      Overview–Investments and Acquisitions–Cicero.”) Additional amount is attributed
      to a dividend received from Steps Ventures, an Israeli venture capital
      investment group, in which we hold 375,000 shares representing 3.75% of its
      outstanding share capital. The dividend received in 2007 was $134,000 compared
      to $282,000 in 2006.





*Income
      tax expense.* In 2007,
      we had tax expense of $68,000 compared to income tax benefits of $282,000 in
      2006. The tax expenses are compound from taxes related to prior years in the
      amount of $208,000 and tax related to current year which include tax benefit
      related to exercise of share-options in the amount of $594,000 offset by $1.0
      million deferred tax which represents our estimated tax benefits in the next
      three years. The income tax benefit in 2006 was related to the final settlement
      of tax assessments with the Israeli Income Tax Authorities, which was partially
      offset by our local taxes paid worldwide by our international subsidiaries.
      We
      have net operating losses carried forward for tax purposes for the amount of
      $78.0 million that resulted in relative low tax rate charges comparing to our
      income before tax results.





*Minority
      interest* .
      Minority interest in losses in 2007 was $163,000 representing our minority
      share
      in the net profit of Liacom, Zulu and Mainsoft. Minority interest in earning
      in
      2006 was $317,000, representing our minority share in the net losses of these
      companies. There were no changes in our minority interest.




47





**Years
      Ended December 31, 2006 and 2005**





*Revenues.* Revenues
      increased 15% from $58.9 million in 2005 to $68.0 million in 2006, representing
      15% of the overall revenues in each of these years. Revenues generated from
      products grew 17% from $8.7 million in 2005 to $10.2 million in 2006. Revenues
      from services grew 15% from $50.2 million in 2005 to $57.9 million in 2006.
      The
      product mix has not changed in 2006. We attribute the revenue growth of our
      services and products to the same key factors.





·
            The
                growing realization by major enterprises those are dependent on legacy
                core systems, of the inevitability of IT modernization to remain
                effective, competitive and efficient.





·
            We
                have expanded our product offering throughacquisitionsand internal development efforts. Tools such as Natural/ADABAS to
                JAVA and
                IMS migration were introduced during 2006 and were integrated into
                BluePhoenix’s suiteof
                solutions.




·
            We
                have strengthened our sales team and devoted significant management
                attention to increase market awareness and to establish a strong
                reputation as a leader in the modernization market. We have also
                increased
                our marketing efforts through targeted exhibitions, an expanded public
                relations program, web and email marketing, online web casts and
                other
                lead generation campaigns. These have significantly contributed to
                increasing the interest in our products and solutions and have helped
                to
                drive the growth in revenues.





The
      price
      of a modernization project mainly depends on the number of lines of code to
      be
      converted, and is determined independently of the source and target platforms.
      As a result, the prices of our solutions do not fluctuate
      significantly.





*Cost
      of revenues.* Cost of
      revenues increased 12% from $25.4 million in 2005 to $28.5 million in 2006.
      Cost
      of revenues as a percentage of revenues decreased 1.2% from 43.1% in 2005 to
      41.9% in 2006. The decrease in cost of revenues as a percentage of revenues
      was
      mainly due to the expansion of our offshore centers, a process that continued
      in
      2007. During 2006, we increased the number of professional employees in our
      offshore centers by 11%. These employees enabled us to replace on-site facility
      employees, thus decreasing the number of relatively expensive technical experts.
      The reduction in costs in our offshore centers relative to the costs in our
      on-site facilities resulted in an average savings of 30%-50% per employee.
      In
      addition, as the degree of automation of our tools increases, the need for
      expert services decreases, and as a result our direct expenses
      decrease.





The
      total
      amount of amortization of intangible assets in 2006 was $7.1 million, compared
      to $5.5 million in 2005. This increase was related to the general release of
      developed modernization tools and the amortization of intangibles related to
      2006 acquisitions *.*





*Research
      and development costs.* Research
      and development costs, net, increased from $8.0 million in 2005 to $9.4 million
      in 2006. As a percentage of revenues, research and development costs, net
      remained at 14%.




48





Research
      and development costs, gross, increased from $16.3 million in 2005 to $17.7
      million in 2006. As a percentage of revenues, research and development costs,
      gross decreased to 26% in 2006 compared to 27.7% in 2005. This decrease was
      primarily due to the market release of developed modernization tools and a
      reduction in costs by using our offshore centers.





Research
      and development costs are charged to operations as incurred, unless capitalized
      according to SFAS 86. In 2006, we capitalized research and development costs
      in
      an aggregate amount of $8.2 million compared to $8.0 million in 2005. During
      2005 and 2006, we introduced several new solutions:




·
            BluePhoenix
                LogicMiner – a solution for understanding and mining COBOL applications;


·
            BluePhoenix
                Redevelopment SOA – a new redevelopment solution for converting COBOL
                applications to Java and C#; and


·
            Automated
                tool for converting ADABAS/Natural applications to Java using rational
                databases.





*Selling,
      general and administrative expenses.* Selling,
      general and administrative expenses increased from $21.6 million in 2005 to
      $22.1 million in 2006. During 2006, our expanded marketing efforts lead to
      a
      significant growth in revenue and in number of new signed deals during
      2007.





*Financial
      expenses, net.* Financial expenses in 2006 were $3.5 million compared to $2.0 million in 2005.
      The increase in financial expenses is mainly attributable to the issuance of
      convertible notes in February 2006 and convertible debentures in March 2006.
      The
      calculation of the discount amortization and the fair value adjustments of
      related financial instruments resulted in non-cash financial expenses. The
      non-cash expenses related to the convertible notes and debentures were $1.2
      million in 2006 compared to $556,000 in 2005. In addition, the increase in
      financial expenses was attributable to the increase of our overall borrowings
      from banks.





*Other
      income, net.* Other
      income, net in 2006 was $282,000 compared to $104,000 in 2005. Other income
      in
      2006 consists of dividend received from Steps Ventures, an Israeli venture
      capital investment group.





*Income
      tax expense, net.* In 2006,
      we had income tax benefit, net of $282,000 compared to an expense of $149,000
      in
      2005. The income tax benefit in 2006 was related to the final settlement of
      tax
      assessments with the Israeli Income Tax Authorities, which was partially offset
      by our local taxes paid worldwide by our international
      subsidiaries.





*Minority
      interest in profits of subsidiaries* .
      Minority interest in 2006 includes $204,000 representing the minority share
      in
      the profits of Mainsoft, $88,000 representing the minority share in the profits
      of Liacom Systems and $25,000 representing the minority share in the profits
      of
      Zulu Software Inc.




49




**B.**  **Liquidity
      and Capital Resources** ****





***How
      We Have Financed Our Business***





In
      1997,
      we consummated two public offerings, and received net proceeds of $33.9 million
      after deducting underwriting discounts and commissions and offering expenses.





On
      March
      30, 2004, we completed a private placement to institutional investors. Under
      the
      terms of this transaction as amended on February 18, 2005, we issued to the
      institutional investors, for an aggregate purchase price of $5 million,
      convertible debentures due in 2007, bearing interest at a rate of six months
      LIBOR paid quarterly. Pursuant to our agreement with the institutional
      investors, in March 2006, the institutional investors exercised their right
      to
      purchase from us, for an aggregate purchase price of $3 million, additional
      convertible debentures due in 2009. As of December 31, 2007, the institutional
      investors converted the entire principal amount of the debentures into 1,620,790
      of our ordinary shares. For
      more
      information regarding the private placement, see “– Contractual Commitments and
      Guarantees.”





In
      February 2006, we completed an underwritten public offering in Israel of series
      A convertible notes in an aggregate principal amount NIS 54.0 million that
      were
      equal at the time of the transaction to approximately $11.5 million (the dollar
      amount was calculated based on the exchange rate at the date of the
      transaction). As of December 31, 2007, 99.4% of the notes were converted into
      2,070,373 ordinary shares.





In
      order
      to improve our liquidity, we entered into sale of receivables’ agreements with
      regard to some of our customers, and control and risk of those trade receivables
      were fully transferred. This facility enables us to receive a short term
      financing from time to time, as the related costs of the financing are similar
      to the costs of credit lines from banks, and no covenants are required. In
      2007,
      an amount of $11.4 million was sold. As of March 26, 2008, the remaining amount
      outstanding, as reflected in the interest charges, was $800,000.





In
      November 2007, we completed a $35 million private placement of ordinary shares
      and warrants issued to institutional investors. Under the Securities Purchase
      Agreement entered into with the institutional investors, we sold to the
      investors 2,000,000 ordinary shares at a purchase price of $17.50 per share.
      The
      investors were also granted warrants to purchase 800,000 ordinary exercisable
      during a 5-year term at an exercise price of $21.88. The net proceeds from
      the
      offering were mainly used for repayment of debt . As
      agreed
      with the investors, we registered the shares purchased by the investors and
      those underlying the warrants for resale under an effective registration
      statement.





We
      have
      entered into credit facilities with Bank Discount Le’Israel Ltd., Bank Ha’Poalim
      Ltd. Bank Leumi Le’Israel Ltd. and the First International Bank Ltd., for credit
      facilities of up to an aggregate of $33.5 million. We used the proceeds from
      the
      private placement completed in November 2007 to repay our outstanding loans
      to
      the banks . As of December 31, 2007, we had no outstanding loans under our
      credit facilities with the banks. In recent years, we used these credit
      facilities to finance certain acquisitions, to give guarantees, and for interim
      financing, in accordance with our cash requirements. These credit facilities
      provide for loans in various currencies and bear various interest rates. To
      the
      extent we borrow under our credit facilities, we would be required to comply
      with certain covenants related to our operations, such as:




50





·
            maintaining
                a minimum level of shareholders’ equity of no less than 40% of our total
                assets and no less than $50
                million;


·
            maintaining
                a minimum level of tangible shareholders’ equity of no more than a deficit
                of $30 million;


·
            maintaining
                a level of annual operating income before depreciation and amortization
                of
                no less than $5 million; and


·
            maintaining
                a ratio of our bank liabilities to current assets, excluding other
                current
                assets, of no more than 40%.





To
      date,
      we have met all such covenants. We may use these credit facilities in the
      future.





As
      of
      December 31, 2007, we had cash and cash equivalents (including marketable
      securities) of $26.6 million and working capital of $25.3 million. As of
      December 31, 2006, we had cash and cash equivalents of $12.7 million and working
      capital of $17.9 million.





Net
      cash
      provided by operating activities was $17.3 million in 2007 compared to $10.0
      million in 2006. Cash provided by operating activities was improved primarily
      as
      a result of the increase in our financial results. Although we incurred a loss
      of $8.2 million, $23 million were non-cash charges, such as depreciation and
      amortization, goodwill impairment and stock-based compensation.




***Capital
      Expenditures***




Our
      capital expenditures include the consideration paid for acquired activities
      and
      technologies.





In
      2007,
      we invested $2.0 million in BridgeQuest Inc. and $7.0 million in ASNA, our
      newly
      consolidated subsidiaries. Additional consideration paid for previously acquired
      subsidiaries amounted to $1.3 million. The additional consideration was paid
      to
      CodeStream and Outlook. For more information about the transactions with
      CodeStream and Outlook, see “Item 4.B. Business Overview–Investments and
      Acquisitions–CodeStream-Outlook.”





Investment
      in property and computer equipment required to support our research and
      development activities were $1.1 million in 2007 and $676,000 in
      2006.





In
      the
      last three years, we did not repurchase any shares under our buy-back programs.
      However, on March 20, 2008, we announced that our board of directors has
      authorized the repurchase of our shares, subject to market conditions, under
      our
      existing buy-back programs. As of December 31, 2007, we had repurchased
      1,870,565 of our ordinary shares under our buy-back programs, for an aggregate
      of approximately $14.7 million. Under our buy-back programs, we may purchase
      our
      shares from time to time, subject to market conditions and other relevant
      factors affecting us.




51




Under
      the
      Israeli Companies Law, 1999, referred to as the Companies Law, the repurchased
      shares do not confer upon our subsidiaries any voting rights (although they
      entitle their holders to participation rights upon distribution). The first
      buy-back program adopted in May 1998 enables us to purchase our shares, through
      a subsidiary, utilizing up to $5 million. Under the second buy-back program
      adopted in September 1998, and amended in May 1999, we may purchase, through
      a
      subsidiary as a trustee, up to an additional 2,000,000 ordinary shares. Under
      the two plans we may acquire an additional 700,000 shares at the current share
      price. The closing price of our ordinary shares as quoted on the NASDAQ Global
      Market on March 26, 2008 was $9.06.





We
      believe that cash generated from operations together with existing sources
      of
      liquidity and cash flow, will be sufficient to meet our anticipated cash needs
      for at least the next 18 months.





***Contractual
      Commitments and Guarantees***





*Convertible
      Debentures and Warrants Issued in a Private Placement to Institutional
      Investors*





On
      March
      30, 2004, we completed a private placement to institutional investors. Under
      the
      terms of this transaction as amended on February 18, 2005, we issued to the
      institutional investors, for an aggregate purchase price of $5 million,
      convertible debentures due in 2007, bearing interest at a rate of six months
      LIBOR paid quarterly, and warrants, exercisable until September 2009, for
      285,714 ordinary shares at a purchase price of $6.50 per share. Pursuant to
      our
      agreement with the institutional investors, in March 2006, the institutional
      investors exercised their right to purchase from us, for an aggregate purchase
      price of $3 million, additional convertible debentures due in 2009 and warrants,
      exercisable until September 2011, for 200,000 ordinary shares at a purchase
      price of $4.50 per share.





As
      of
      December 31, 2007, the institutional investors converted the entire principal
      amount of the debentures into 1,620,790 of our ordinary shares. None of the
      warrants have been exercised. As
      agreed
      upon by the investors, we registered the shares underlying the warrants for
      resale under an effective registration statement.





*Warrants
      Issued in November 2007*





In
      November 2007, as part of the $35 million private placement, we issued to
      institutional investors warrants to purchase an aggregate of up to 800,000
      BluePhoenix ordinary shares at an exercise price of $21.88 per share, subject
      to
      certain adjustments. These warrants may be exercised during a 5-year period,
      which commenced in November 2007. As agreed upon by the investors, we registered
      the shares underlying the warrants for resale under an effective registration
      statement.




52





*Series
      A Convertible Notes Offered to the Public in Israel*





In
      February 2006, we completed an underwritten public offering in Israel of series
      A convertible notes in an aggregate principal amount of NIS 54.0 million that
      were equal at that time to approximately $11.5 million. Interest on the notes
      was LIBOR 3 months +1.5% per annum. The notes and the shares underlying the
      notes were registered for trading on the TASE. On February 19, 2008, the TASE
      delisted the convertible notes, since substantially all of the notes have been
      converted into ordinary shares and the minimum holdings requirement is not
      maintained. As of March 26, 2008, 99.4% of the convertible notes have been
      converted.





*CodeStream
      Transaction*





Pursuant
      to the purchase agreement of CodeStream business activities, as amended in
      December 2007, we are required to issue to CodeStream up to 1,000,000
      BluePhoenix ordinary shares if certain conditions are met. For more information,
      see “Item 4.B. Business Overview–Investments and Acquisitions–CodeStream
      Software Ltd.”





*Chief
      Scientist*





Three
      of
      our subsidiaries have entered into agreements with the Office of the Chief
      Scientist, or OCS. These subsidiaries are obliged to pay royalties to the OCS
      at
      a rate of 3% on sales of the funded products, up to 100% of the dollar-linked
      grant received in respect of these products from the OCS. As of December 31,
      2007, the contingent liability amounted to $3.1 million, of which Mainsoft
      share
      is $2.2 million.





*Singapore-Israel
      Industrial Research and Development Foundation*





In
      the
      first quarter of 2004, the Singapore-Israel Industrial Research and Development
      Foundation agreed to provide one of our wholly owned subsidiaries, together
      with
      a company incorporated in Singapore, financing for the development of a Java
      report-generator software tool. Accordingly, the foundation agreed to award
      our
      subsidiary up to $100,000 payable according to an agreed-upon schedule. As
      of
      December 31, 2007, we received $45,000 of the grant. The grant is required
      to be
      repaid in installments based on sales of the funded software up to the amount
      of
      the grant.





*Ministry
      of Production in Italy*





In
      July
      2007, our subsidiary, I-Ter, received a final approval from the Ministry of
      Production in Italy for its Easy4Plan product. Easy4Plan is a workflow
      management tool designed for ISO9000 companies. The total funds amounted to
      approximately $650,000, of which 30% constitute a grant, and the balance is
      an
      8-year loan to be repaid by I-Ter. The loan bears a minimal annual interest.
      90%
      of the funds were received in December 2007. The remaining 10% are expected
      to
      be received during 2008 after a review of the Ministry of
      Production.




53




*Customers’
      bank guarantees*





Under
      agreements between us and certain of our customers, we undertook to provide
      these customers with bank guarantees for the assurance of performance of our
      obligations under our agreements with such customers. As of December 31, 2007,
      there are outstanding bank guarantees on our behalf for our customers in the
      aggregate amount of $52,000.





*Operating
      leases*





We
      are
      committed under operating leases for rental of office facilities, vehicles,
      and
      other equipment for the years 2008 until 2014. Annual rental fees under current
      leases are approximately $3.0 million, and are expected to remain at this level
      for each of the next three years. In connection with the office leases, we
      issued bank guarantees of $101,000 in the aggregate.




*Indemnification
      of Office Holders*





We
      entered into an undertaking to indemnify our office holders in specified limited
      categories of events and in specified amounts, subject to certain limitations.
      For more information, see “Item 7.B. Related Party Transactions –
Indemnification of Office Holders.”





***Effective
      Corporate Tax Rates***





Following
      the tax reform enacted in 2003, an Israeli company is subject to tax on its
      worldwide income. An Israeli company that is subject to Israeli taxes on the
      income of its non-Israeli subsidiaries will receive a credit for income taxes
      paid by the subsidiary in its country of residence. Israeli tax payers are
      also
      subject to tax on income from a controlled foreign corporation, according to
      which an Israeli company may become subject to Israeli taxes on certain income
      of a non-Israeli subsidiary, if such subsidiary’s primary source of income is a
      passive income (such as interest, dividends, royalties, rental income, or
      capital gains).





On
      January 1, 2006, an additional tax reform has been taken place relating
      primarily to profits from investments. The main goal of the reform was to unify
      the tax rates applicable to profits from investments, such as interest, capital
      gains, and dividends. In addition, under the new reform, the tax rates
      applicable to companies were reduced to 29% in 2007, 27% in 2008, 26% in 2009,
      and 25% from 2010 and on.





Our
      international operations are taxed at the local effective corporate tax rate
      in
      the countries of our subsidiaries’ residence. We believe that in the future we
      will derive an increasing percentage of our income from operations outside
      of
      Israel and that, accordingly, our effective tax rate may increase. However,
      we
      expect that this increase will be offset by carried forward accumulated losses
      of consolidated companies.




54




**C.**  **Research
      and Development, Patents and Licenses**





For
      a
      description of our research and development activities, see “Item 4.B. Business
      Overview – Research and Development.”





For
      information concerning our intellectual property rights, see “Item 4.B. Business
      Overview – Intellectual Property.”




**D.**  **Trend
      Information** ****





Economic
      changes such as the U.S. subprime mortgage loan crisis and the economic
      instability caused by the rise in oil prices, are affecting companies’
willingness, in both the U.S. and in Europe, to make capital spending on IT
      projects. We cannot know whether IT capital spending and investment in IT
      projects will continue in the future at the same level, or how the economic
      conditions will affect our business. Accordingly, we cannot assure you that
      we
      will be able to increase our revenues or keep our revenues at the same level
      as
      in 2007. As we continue to market new products and penetrate international
      markets, we expect our selling, general and administrative expenses to continue
      to be relatively high.




**E.**  **Off-Balance
      Sheet Arrangements**





None.




**F.**  **Tabular
      Disclosure of Contractual Obligations** ****





The
      following table summarizes our contractual obligations and commitments as of
      December 31, 2007:





**Payment
                due by period****Total**
            
            **Less
                than**
              **1
                year**
            
            **1-3**
              **years**
            
            **4-5**
              **years**
            
            **More**
              **than
                5**
              **years**In
                thousands $Contingent
                consideration
            
            
            8,754
            
            
            8,754
            
            
            -
            
            
            -
            
            
            -Long
                term debt obligations
            
            
            135
            
            
            -
            
            
            135
            
            
            -
            
            
            -Operating
                lease obligations
            
            
            5,826
            
            
            2,965
            
            
            2,704
            
            
            157
            
            
            -**Total**
            
            
            14,715
            
            
            11,719
            
            
            2,839
            
            
            157
            
            
            -





The
      above
      table does not include interest payments and royalties that we may be required
      to pay to the OCS and that may reach, in the aggregate, as of December 31,
      2007,
      $3.1 million. For more information about grants received from the OCS, see
“Item
      4.B. Business Overview - Research and Development.” We are unable to reasonably
      estimate the amounts that we will eventually be required to pay to the OCS,
      if
      at all, and the timing of such payments, since these payments depend on our
      ability to sell products based on the OCS-funded technologies and the timing
      of
      such sales, if any.




55




**G.**  **Safe
      Harbor**





The
      safe
      harbor provided in Section 27A of the Securities Act and Sections 21E of the
      Exchange Act shall apply to forward-looking information provided in Items 5.E
      and F.




**ITEM
      6. DIRECTORS, SENIOR MANAGEMENT, AND EMPLOYEES**




**A.**  **Directors
      and Senior Management**





The
      following table describes information about our executive officers and directors
      as of March 26, 2008 **.**





**Name**
            
            **Age**
            
            **Position**Arie
                Kilman
            
            55
            
            Chief
                Executive Officer, DirectorShai
                Beilis (1)
            
            59
            
            DirectorMichael
                Chill (1)(2)
            
            41
            
            DirectorAmira
                Berkovitz-Amir (1)(2)
            
            41
            
            DirectorVarda
                Sagiv
            
            47
            
            Chief
                Financial OfficerEliezer
                Harkavi
            
            58
            
            Chief
                Operations OfficerDavid
                Leichner
            
            45
            
            Chief
                Marketing OfficerYossi
                Shemesh
            
            44
            
            Vice
                President, OperationYael
                Peretz
            
            34
            
            General
                CounselGreg
                Schottland
            
            44
            
            Vice
                President, Sales, North AmericaTom
                O’Connell
            
            37
            
            Vice
                President, Research and DevelopmentPesach
                Gal-On
            
            54
            
            Vice
                President, PresalesTzvia
                Shmuelevich
            
            54
            
            Vice
                President, Worldwide Delivery


________________


(1)
            Member
                of the audit committee and independent director under The Nasdaq
                Global
                Market listing requirements.


(2)
            An
                outside director.





**Arie
      Kilman** has
      served as our chief executive officer and director since May 2003. Mr. Kilman
      has also served as president and chief executive officer of BluePhoenix
      Solutions B.V. since its inception in October 2001. Mr. Kilman previously served
      as the president of Liraz,
      which he founded in 1984, and managed since then. From 1998 to July 2000, Mr.
      Kilman served as chief executive officer of Level 8. Mr. Kilman holds a BA
      degree in economics and computer science from New York University.





**Aaron
      Crystal** founded
      our company (previously named Crystal Systems Solutions Ltd.) in 1987, and
      served as one of our directors since our formation until he passed away on
      February 25, 2008.




56





**Shai
      Beilis** served
      as chairman of our board of directors from December 1995 until April 1998 and
      as
      vice chairman of our board of directors from April 1998 until November 1999.
      Mr.
      Beilis continues to serve as one of our directors. Mr. Beilis currently serves
      as chairman and chief executive officer of Formula Ventures Ltd. Mr. Beilis
      also
      served as a director of Formula Systems (1985) Ltd. from December 1997 until
      February 2005. Mr. Beilis holds a B.Sc. in mathematics and economics from the
      Hebrew University in Jerusalem (cum laude) and an MA in computer science from
      the Weizmann Institute of Science.





**Michael
      Chill** has
      served as one of our outside directors and a member of our audit committee
      since
      July 2003. From July 2005, Mr. Chill has served as Co-head of the Direct
      Investments at Paramount Biocapital Asset Management Inc, a venture capital
      hedge fund and broker dealer. Prior to that, Mr. Chill served as an analyst
      and
      independent advisor to various high technology companies and venture capital
      firms both in Israel and the United States. During 2000 and the first half
      of
      2001, Mr. Chill served as the president and head of investment banking
      department at Jerusalem Global Ltd., a venture capital and investment banking
      firm. Prior to that, from 1999, Mr. Chill served as a managing director in
      the
      technology investment banking group at Gruntal and Co. Mr. Chill holds a B.S.
      in
      accounting from the Sy Syms School of Business at Yeshiva University and an
      MBA
      from the Columbia Business School.





**Amira
      Berkovitz -Amir** has
      served as one of our outside directors and as a member of our audit committee
      since December 2004. From March 2007, Ms. Berkovitz-Amir is the director of
      finance of the Baruch Padeh Medical Center, Poriya. Until October 2005, Ms.
      Berkovitz-Amir served as vice president, finance of Of-Tov Products (2001)
      Ltd.,
      a manufacturer in the food industry and a member of Osem Industries Group.
      Previously, Ms. Berkovitz-Amir served as vice president, finance and controller
      of Pri-Hagalil Industries, a manufacturer in the food industry. Ms.
      Berkovitz-Amir holds a BA degree in economics and accounting and an MA in
      business administration, both from the Hebrew University. Ms. Berkovitz-Amir
      is
      a certified public accountant in Israel.





**Varda
      Sagiv** has
      served as our chief financial officer since June 2007. From 1998 until 2007,
      Ms.
      Sagiv served as the chief financial officer of Formula Ventures Ltd., a venture
      capital fund manager. Ms. Sagiv holds a BA in accounting from Tel Aviv
      University, and is a certified public accountant in Israel.





**Eliezer
      Harkavi** has
      served as our chief operations officer since January 2007. In his prior roll,
      since 1997, Mr. Harkavi served as our vice president of delivery and research
      and development. Prior to that, Mr. Harkavi served for 10 years as a director
      of
      software development at Aurec, currently Amdocs Ltd., a worldwide leader in
      customer care and billing systems. His responsibilities included management
      of
      several major development and implementation projects in the USA and Europe.
      Mr.
      Harkavi holds a BS in industrial engineering and management (cum laude) from
      the
      Technion, Israel Institute of Technology.


57




**David
      Leichner** has
      served as our chief marketing officer since June 2007. Prior to joining
      BluePhoenix, Mr. Leichner held executive management positions at Telrad
      Networks, Unipier and Magic Software Enterprises. He has also held various
      marketing management and technical positions at Information Builders, TRW Space
      and Defense and Salomon Brothers. Mr. Leichner holds a BA in systems management
      and an MBA in international marketing from City University of New
      York.




**Yossi
      Shemesh** has
      served as our vice president, operations since March 2003. Prior to its purchase
      by BluePhoenix, Mr. Shemesh was chief financial officer, and then chief
      executive officer, of Liraz Systems Ltd. He also served as chairman of Yaana
      Systems. Before that, he was an audit manager at the accounting firm of
      Jungerman, Gilboa, Silber, CPA. Mr. Shemesh holds an executive MBA from Tel
      Aviv
      University, a BA from Ben Gurion University, and is a certified public
      accountant in Israel.





**Yael
      Peretz** has
      served as our general counsel since 2000. Prior to joining BluePhoenix, Ms.
      Peretz worked as a lawyer with Shine, Hunter & Martin, a law firm. Ms.
      Peretz holds an LLB from the Hebrew University in Jerusalem and an MA in
      business administration from Tel Aviv University. Ms. Peretz is a member of
      the
      Israel Bar.





**Greg
      Schottland******has
      served as our vice president, sales, North America since December 2006, when
      we
      acquired certain business activities of CodeStream (formally Xitec Software)
      where he served as president. Prior to his work in the legacy modernization
      market, he founded and led Advanced Software Technologies. Mr. Schottland holds
      an M.S. in computer science from the University of Illinois and a B.S. in
      business from the University of Colorado.





**Tom
      O’Connell** has
      served as our vice president, research and development since September 2005.Mr.
      O’Connell joined BluePhoenix in October 2001 and served as director of research
      and development. Prior to joining BluePhoenix, Mr. O’Connell was the manager of
      development and support for Level 8 Systems. Prior to Level 8, Mr. O’Connell was
      the software development manager for Seer Technologies. Mr. O’Connell received a
      B.S. in computer science from the University of Pittsburgh.





**Pesach
      Gal-On** has
      served as our vice
      president, presalessince
      January 2006. Prior to his current role, Mr. Galon served as founder, chief
      technology officer and senior projects manager for Outlook Systems, which was
      acquired by us in January 2004. Mr. Galon graduated from the Israeli military
      academy for computer science, and completed extensive IDMS training at Cullinet
      Inc.





**Tzvia
      Shmuelevich**  has
      served as our vice president, worldwide delivery since January 2007.Prior to
      her current role at BluePhoenix, Ms. Shmuelevich served for 20 years as
      co-founder and delivery manager for Outlook Systems. Ms. Shmuelevich graduated
      as a practical engineer from the Ort Israeli Academy.


58




**B.**
            **Compensation******




In
      2007,
      we paid to our outside directors and executive officers, as a group (15
      persons), aggregate remuneration of approximately $1.8 million. This amount
      includes bonuses and amounts set aside or accrued to provide pension, social
      security or similar benefits but do not include amounts expended by us for
      automobiles made available to our officers and expenses (including business
      travel, professional and business association dues and expenses) reimbursed
      to
      officers. In addition, Formula Systems (1985) Ltd., our former controlling
      shareholder, has paid a bonus of $1.8 million to Mr. Kilman, our chief executive
      officer, as compensation with respect to the sale by Formula of its shareholding
      in BluePhoenix.





The
      aggregate remuneration set forth in the foregoing paragraph does not include
      amounts we paid to Formula, our former controlling shareholder, under the terms
      of a management agreement, as consideration for management services rendered
      to
      us by certain directors designated by Formula. This agreement was terminated
      in
      June 2007 when Formula sold its controlling interest in BluePhoenix. See “Item
      7.B. Related Party Transactions.”





Under
      Israeli law, we are not required to disclose, and have not otherwise disclosed,
      the compensation of our senior management and directors on an individual basis,
      except for Mr. Kilman, our chief executive officer, and Mr. Shai Beilis, whose
      compensation was recently approved by our shareholders.





We
      maintain written employment agreements with our officers. The employment
      agreements are not for a specific term and we may terminate them upon prior
      notice of between one and nine months. If we terminate the employment
      agreements, we will have to pay the usual severance pay required under Israeli
      law for all employees. Our directors, unless they also serve as officers, are
      not entitled to any benefits upon termination. The agreements with our officers
      provide for annual base salary and other benefits like vacation, sick leave,
      provision of an automobile, insurance contributions, and non-compete and
      confidentiality agreements. We had a similar agreement with Ms. Iris Yahal,
      our
      former chief financial officer, who resigned from her position on May, 31,
      2007.





In
      December 2007, our shareholders approved, following the approval of our audit
      committee and our board of directors, the compensation of Mr. Arie Kilman,
      our
      chief executive officer, as follows: (i) an annual salary of $320,000, paid
      monthly; (ii) 30,000 restricted share units, referred to as RSUs, to be granted
      on January 1, 2008 and on the first day of each following year of service;
      and
      (iii) a quarterly bonus of $40,000 and 3,750 RSUs, if the targets described
      below are achieved:




**Period**
            
            **Revenues (in $)**
            
            **Net Non-GAAP**
              **Profit (in $)**Q1
                2008
            
            $
            25.6
                million
            
            $
            4.1
                millionQ2
                2008
            
            $
            27.0
                million
            
            $
            4.9
                millionQ3
                2008
            
            $
            28.5
                million
            
            $
            5.1
                millionQ4
                2008
            
            $
            30.2
                million
            
            $
            5.4
                millionTotal
                2008
            
            $
            111.3
                million
            
            $
            19.5
                million


59




The
      net
      non-GAAP profit shall be as set forth in our financial statements. If the net
      non-GAAP profit target is met and the revenues target is not met, Mr. Kilman
      will be entitled to 50% of the bonus. If the revenues target is met and the
      non-GAAP earning per share is $0.125 or more, Mr. Kilman will be entitled to
      50%
      of the bonus. The targets mentioned in the table above refer to 2008 and will
      be
      updated each year. The bonus will be paid at the end of each fiscal quarter.
      Non-GAAP results exclude discontinued operations, impairment of intangible
      assets, restructuring, acquisition related and integration charges, amortization
      and capitalization of intangible assets, the effect of stock-based compensation
      and non-cash financial and other expenses mainly related to convertible
      debentures.




The
      RSUs
      shall vest in three equal installments over a 3-year period, on the date of
      grant and on the first day of each of two additional years of service. The
      grant
      of the RSUs shall be under the terms set forth in our 2007 Award Plan and in
      accordance with our standard grant letter.




In
      addition, in December 2007, our shareholders approved, following the approval
      of
      our audit committee and our board of directors, the payment of compensation
      to
      Shai Beilis, a non-employee director, in the same amounts that were approved
      for
      compensation of our outside directors, as follows: ****** (i)
      an
      annual cash payment in the amount of $8,000 (payable in four equal quarterly
      installments); and (ii) a payment of $600 per board meeting, referred to as
      the
      base rate. In accordance with the regulations promulgated under the Companies
      Law, the payment for telephone meetings (or a meeting held by other similar
      means) will be equal to 60% of the base rate, and payment for written
      resolutions will be equal to 50% of the base rate. These payments shall be
      made
      on the first day of each quarter for the preceding quarter.




In
      addition, the shareholders approved the grant of RSUs to each of our
      non-employee directors ( *i.e.,* Shai
      Beilis and the two outside directors, Amira Berkovitz-Amir and Michael Chill),
      as follows: (i) 4,000 RSUs on January 1, 2008; and (ii) 3,000 RSUs on the first
      day of each following year of service as our director.




The
      RSUs
      shall vest in three equal annual installments over a 3-year period, on the
      date
      of grant of the RSUs and on the first day of each of two additional years of
      service. The grant of the RSUs shall be under the terms set forth in our 2007
      Award Plan and in accordance with our standard grant letter.




**C.**
            **Board
                Practices**





Pursuant
      to our articles of association, directors are elected at a general meeting
      of
      our shareholders by a vote of the holders of a majority of the voting power
      represented at the meeting. Additional directors may be elected between general
      meetings by a majority of our directors. Our board is comprised of 4 persons,
      of
      which 3 have been determined to be independent within the meaning of the
      applicable NASDAQ requirements. Two of these independent directors also serve
      as
      outside directors mandated under Israeli law and subject to additional criteria
      to help ensure their independence. See “Outside Directors,” below. Each
      director, except for the outside directors, holds office until the next annual
      general meeting of shareholders. Officers are appointed by our board of
      directors.


60





Our
      board
      of directors has appointed an option committee, comprised of Messrs. Shai
      Beilis, Amira Berkovitz-Amir and Arie Kilman. The option committee is
      responsible for granting options and restricted share units to employees and
      consultants. The independent board members approve compensation for executive
      officers.




The
      compensation of our executive officers is determined by independent members
      of
      our board of directors. The compensation of officers that requires the approval
      of the audit committee or any other additional approval under applicable law,
      is
      also brought for such entities’ additional approval .





***Outside
      Directors***





Under
      the
      Companies Law, companies incorporated under the laws of Israel whose shares
      have
      been offered to the public in or outside of Israel, are required to appoint
      at
      least two outside directors. The Companies Law provides that a person may not
      be
      appointed as an outside director if the person or the person’s relative,
      partner, employer or any entity under the person’s control, has, as of the date
      of the person’s appointment to serve as outside director, or had, during the two
      years preceding that date, any affiliation with the company or any entity
      controlling, controlled by or under common control with the company. The term
      “affiliation” includes:





·
            an
                employment relationship;


·
            a
                business or professional relationship maintained on a regular
                basis;


·
            control;
                and


·
            service
                as an office holder.





No
      person
      may serve as an outside director if the person’s position or other business
      activities create, or may create a conflict of interest with the person’s
      responsibilities as an outside director or may otherwise interfere with the
      person’s ability to serve as an outside director or if the person is an employee
      of the Israel Securities Authority or of an Israeli stock exchange. If, at
      the
      time of election of an outside director, all other directors are of the same
      gender, the outside director to be elected must be of the other gender. Outside
      directors are elected by a majority vote at a shareholders’ meeting, provided
      that either:





(1)
            the
                majority of shares voted at the meeting, including at least one-third
                of
                the shares of non-controlling shareholders or their representatives
                voted
                at the meeting, vote in favor of election;
                or





(2)
            the
                total number of shares of non-controlling shareholders voted against
                the
                election of the outside director does not exceed one percent of the
                aggregate voting rights in the
                company.





Pursuant
      to the Companies Law, all outside directors must have financial and accounting
      expertise or professional qualifications, and at least one outside director
      must
      have financial and accounting expertise. The terms “financial and accounting
      expertise” and “professional qualifications” have been defined in regulations
      promulgated under the Companies Law.


61





The
      initial term of an outside director is three years and may be extended for
      an
      additional three years. At present, Mr. Michael Chill and Ms. Amira
      Berkovitz-Amir serve as our outside directors, Mr. Chill to hold office until
      July 2009 and Ms. Berkovitz-Amir until December 2010. In accordance with the
      Israeli Companies Regulations (Alleviation for Public Companies Whose Shares
      are
      Listed on a Stock Exchange Outside of Israel) 2000, dual listed companies,
      like
      us, may re-appoint an outside director for an additional three-year term, above
      the maximum six-year term permitted under the Companies Law, if the audit
      committee and the board of directors confirm that due to the expertise and
      special contribution of the outside director to the work of the board and its
      committees, his re-appointment is in the best interests of the
      company.




Each
      committee exercising the powers of the board of directors is required to include
      at least one outside director. However, the audit committee should include
      all
      the outside directors.




An
      outside director is entitled to compensation as provided in regulations
      promulgated under the Companies Law and is otherwise prohibited from receiving
      any compensation, directly or indirectly, in connection with services provided
      as an outside director. We compensate our two outside directors in accordance
      with regulations promulgated under the Companies Law.




***Qualifications
      of Other Directors***




Under
      the
      Companies Law, the board of directors of a publicly traded company is required
      to make a determination as to the minimum number of directors who must have
      financial and accounting expertise according to criteria that is defined in
      regulations promulgated under the Companies Law. In accordance with the
      Companies Law, the determination of the board should be based on, among other
      things, the type of the company, its size, the volume and complexity of its
      activities and the number of directors. Based on the foregoing considerations,
      our board determined that the number of directors with financial and accounting
      expertise in our company shall not be less than two.




**Audit
      Committee**




The
      Companies Law requires public companies to appoint an audit committee, comprised
      of at least three directors, which must include all of the company’s outside
      directors. The chairman of the board of directors, any director which is
      employed or provides services to the company, and a controlling shareholder
      or
      any relative of a controlling shareholder, may not be a member of the audit
      committee.




In
      addition, under applicable NASDAQ rules, we are currently required to have
      at
      least three independent directors and to maintain an audit committee, whose
      members are independent of management. Our outside directors qualify as
      independent directors under the applicable NASDAQ rules and those of the
      Securities and Exchange Commission. We have established an audit committee,
      consisting of our two outside directors, Mr. Michael Chill and Ms. Amira
      Berkovitz-Amir, as well as Mr. Shai Beilis, who is considered “independent”
under the applicable NASDAQ rules. The board has determined that both Michael
      Chill and Amira Berkovitz-Amir are “audit committee financial experts” as
      defined by applicable SEC regulations.


62





Under
      the
      Companies Law, the audit committee is responsible for overseeing the business
      management practices of the company in consultation with the company’s internal
      auditor and the independent auditor, making recommendations to the board to
      improve such practices and approving related party transactions as required
      by
      the Companies Law. In accordance with the Sarbanes-Oxley Act and NASDAQ
      requirements, our audit committee is directly responsible for the appointment,
      compensation and oversight of our independent auditors. In addition, the audit
      committee is responsible for assisting the board in monitoring our financial
      statements and the effectiveness of our internal controls. We have adopted
      a
      formal audit committee charter that we have implemented, embodying these
      responsibilities. The audit committee reviews and reassesses the adequacy of
      the
      audit committee charter on an annual basis.





***Internal
      Auditor***





Under
      the
      Companies Law, the board of directors appoints an internal auditor, nominated
      by
      the audit committee. The role of the internal auditor is to examine, among
      other
      matters, whether the company’s actions comply with the law and orderly business
      procedure. Under the Companies Law, the internal auditor may be an employee
      of
      the company but not an office holder, or an interested party (defined as a
      holder of 5% or more of the voting rights in the company or of its issued share
      capital, the chief executive officer of the company or any of its directors,
      or
      a person who has the authority to appoint the company’s chief executive officer
      or any of its directors), or a relative of an office holder or of an interested
      party. In addition, the company’s external auditor or its representative may not
      serve as the company’s internal auditor.





***Approval
      of Certain Transactions under the Companies Law***





The
      Companies Law codifies the fiduciary duties that “office holders,” including
      directors and executive officers, owe to a company. An office holder’s fiduciary
      duties consist of a duty of care and a duty of loyalty. The duty of loyalty
      includes (i) avoiding any conflict of interest between the office holder’s
      position in the company and his personal affairs; (ii) avoiding any competition
      with the company; (iii) avoiding exploiting any business opportunity of the
      company in order to receive personal advantage for himself or others; and (iv)
      revealing to the company any information or documents relating to the company’s
      affairs that the office holder has received due to his position as an office
      holder. Each person listed in the table under “Directors and Senior Management”
above is an office holder.





Under
      the
      Companies Law, arrangements regarding the compensation of directors require
      the
      approval of the audit committee, the board of directors and shareholder
      approval.





The
      Companies Law requires that an office holder of a company promptly disclose
      any
      personal interest that he or she may have and all related material information
      known to him or her, in connection with any existing or proposed transaction
      by
      the company. In addition, if the transaction is an “extraordinary transaction”
as defined under the Companies Law, the office holder must also disclose any
      personal interest held by the office holder’s spouse, siblings, parents,
      grandparents, descendants, spouse’s descendants and the spouses of any of the
      foregoing.


63





In
      addition, the office holder must also disclose any interest held by any
      corporation in which the office holder owns 5% or more of the share capital,
      is
      a director or general manager or in which he or she has the right to appoint
      at
      least one director or the general manager. An “extraordinary transaction” is
      defined as a transaction other than in the ordinary course of business,
      otherwise than on market terms or that is likely to have a material impact
      on
      the company’s profitability, assets or liabilities.





Under
      the
      Companies Law, after the office holder complies with the disclosure requirements
      described above, only board approval is required for any transaction that is
      not
      an extraordinary transaction, unless the articles of association of the company
      provide otherwise, and provided the transaction is not adverse to the company’s
      interest. If the transaction is an extraordinary transaction, the company must
      receive any approval stipulated by its articles of association, the approval
      of
      the audit committee, the approval of the board of directors and shareholder
      approval. An office holder who has a personal interest in a matter that is
      considered at a meeting of the board of directors or the audit committee may
      not
      be present at this meeting or vote on this matter unless the majority of the
      board members or members of the audit committee, as applicable, have a personal
      interest in such matter and in such case, the matter should also be approved
      by
      the shareholders of the company.





The
      Companies Law applies the same disclosure requirements to a controlling
      shareholder of a public company, including a shareholder that holds 25% or
      more
      of the voting rights in the company if no other shareholder owns more than
      50%
      of the voting rights in the company. Extraordinary transactions with a
      controlling shareholder or in which a controlling shareholder has a personal
      interest, and the terms of compensation of a controlling shareholder or its
      relative who is an office holder or an employee of the company, require the
      approval of the audit committee, the board of directors and the shareholders
      of
      the company. The shareholder approval must include at least one-third of the
      shareholders who have no personal interest in the transaction and are voting
      on
      the subject matter or, alternatively, the total shareholdings of those who
      have
      no personal interest in the transaction who vote against the transaction must
      not represent more than one percent of the voting rights in the company. In
      certain cases provided in regulations promulgated under the Companies Law,
      shareholder approval is not required.





The approvals of the board of directors and shareholders are required for a private
      placement of securities (or a series of related private placements during a
      12-month period or that are part of one continuous transaction or transactions
      conditioned upon each other) in which:





·
            the
                securities issuedrepresent at least 20% of the company’s actual voting power prior to the
                issuance of such securities, and such issuance increases the relative
                holdings of a 5% shareholder or causes any person to become a 5%
                shareholder, and the consideration in the transaction (or a portion
                thereof) is not in cash or in securitieslistedon
                a recognized stock exchange, or is not at a fair market value;
                or


·
            a
                person would become, as aresultof
                such transaction, a controlling shareholder of the
                company.


64





Under
      the
      Companies Law, a shareholder has a duty to act in good faith towards the company
      and other shareholders and to refrain from abusing his power in the company
      including, among other things, voting in a general meeting of shareholders
      on
      the following matters:





·
            any
                amendment to the articles of
                association;


·
            an
                increase of the company’s authorized share
                capital;


·
            a
                merger; or


·
            approval
                of interested party transactions that require shareholder
                approval.





In
      addition, any controlling shareholder, any shareholder who knowingly possesses
      power to determine the outcome of a shareholder vote and any shareholder who,
      pursuant to the provisions of a company’s articles of association, has the power
      to appoint or prevent the appointment of an office holder in the company, is
      under a duty to act with fairness towards the company. The Companies Law does
      not describe the substance of this duty.





For
      information concerning personal interests of certain of our office holders
      and
      our principal shareholders in certain transactions with us, see “Item 7.B.
      Related Party Transactions.”





***Exculpation,
      Insurance and Indemnification of Directors and
      Officers***





Under
      the
      Companies Law, an Israeli company may not exempt an office holder from liability
      with respect to a breach of his duty of loyalty, but may exempt in advance
      an
      office holder from his liability to the company, in whole or in part, with
      respect to a breach of his duty of care, provided, however, that such a breach
      is not related
      to a distribution of a dividend or any other distribution by the
      company .





*Office
      Holders Insurance*





Our
      articles of association provide that, subject to the provisions of the Companies
      Law, we may enter into a contract for insurance of all or a part of the
      liability of any of our office holders imposed on the office holder in respect
      of an act performed in his or her capacity as an office holder, in respect
      of
      each of the following:





·
            a
                breach of his duty of care to us or to another
                person;


·
            a
                breach of his duty of loyalty to us, provided that the office holder
                acted
                in good faith and had reasonable cause to assume that such act would
                not
                prejudice our interests; or


·
            a
                financial obligation imposed on him or her in favor of another
                person.


65





*Indemnification
      of Office Holders*





Our
      articles of association provide that, subject to the provisions of the Companies
      Law, we may indemnify our office holders in respect of an obligation or expense
      specified below imposed on an office holder in respect of an act performed
      in
      his or her capacity as an office holder, as follows:





(i)  a
      financial obligation imposed on him or her in favor of another person by a
      court
      judgment, including a compromise judgment or an arbitrator’s award approved by
      court;





(ii)  reasonable
      litigation expenses, including attorney’s fees, incurred by the office holder as
      a result of an investigation or proceeding instituted against the office holder
      by a competent authority, provided that such investigation or proceeding
      concluded without the filing of an indictment against the office holder; and
      either (a) concluded without the imposition of any financial liability in lieu
      of a criminal proceeding; or (b) a financial liability was imposed on him in
      lieu of a criminal proceeding for an offense that does not require proof of
      criminal intent; and





(iii)  reasonable
      litigation expenses, including attorney’s fees, expended by the office holder or
      charged to the office holder by a court, in a proceeding instituted against
      the
      office holder by the company or on its behalf or by another person, or in a
      criminal charge from which the office holder was acquitted, or in a criminal
      proceeding in which the office holder was convicted of an offense that does
      not
      require proof of criminal intent.





We
      may
      undertake to indemnify an office holder as aforesaid, (a) prospectively,
      provided that in respect of (i) above, the undertaking is limited to categories
      of events that in the opinion of our board of directors are foreseeable in
      light
      of the company’s operations at the time that the undertaking to indemnify is
      given, and for an amount or criteria that our board has determined as reasonable
      under the circumstances, and further provided that that such events and amount
      or criteria are indicated in the indemnification undertaking; and (b)
      retroactively.





We
      have
      entered into an undertaking to indemnify our office holders in specified limited
      categories of events and in specified amounts, subject to the limitations set
      by
      the Companies Law and our articles of association, as described above. For
      more
      information, see “Item 7.B. Related Party Transactions – Indemnification of
      Office Holders.”


66





*Limitations
      on Exemption, Insurance and Indemnification*





The
      Companies Law provides that a company may not indemnify an office holder, enter
      into an insurance contract that would provide coverage for any monetary
      liability, or exempt an office holder from liability, with respect to any of
      the
      following:





·
            a
                breach by the office holder of his duty of loyalty, except that the
                company may indemnify or provide insurance coverage to the office
                holder
                if the office holder acted in good faith and had a reasonable basis
                to
                believe that the act would not prejudice the
                company;


·
            a
                breach by the office holder of his duty of care if the breach was
                done
                intentionally or recklessly, except for a breach that was made in
                negligence;


·
            any
                act or omission done with the intent to derive an illegal personal
                benefit; or


·
            any
                fine levied against the office
                holder.





In
      addition, under the Companies Law, indemnification of, and procurement of
      insurance coverage for, our office holders must be approved by our audit
      committee and our board of directors and, in specified circumstances, by our
      shareholders.





We
      have
      procured directors’ and officers’ liability insurance and obtained all necessary
      approvals.




**D.**
            **Employees**





The
      table
      below presents certain information regarding the number of our employees, the
      sector in which they are employed and their geographical area of employment,
      in
      the periods indicated.





**2007**
            
            **2006**
            
            **2005**Technical
                Experts
            
            
            464
            
            
            335
            
            
            260Research
                and Development
            
            
            187
            
            
            150
            
            
            140Sales,
                General and Administrative
            
            
            164
            
            
            130
            
            
            120**Total**
            
            
            **815**
            
            
            **615**
            
            
            **520**In
                Israel
            
            
            242
            
            
            246
            
            
            211In
                Europe
            
            
            464
            
            
            284
            
            
            253In
                the United States
            
            
            109
            
            
            85
            
            
            56





The
      numbers of employees indicated in the table above include expert consultants
      who
      we train for the implementation of our modernization tools and
      methodologies.





With
      respect to our employees in Israel, we are subject to various Israeli labor
      laws
      and labor practices, and to administrative orders extending certain provisions
      of collective bargaining agreements between the Histadrut (Israel’s General
      Federation of Labor) and the Coordinating Bureau of Economic Organizations
      (the
      Israeli federation of employers’ organizations) to all employees in Israel.


67





For
      example, mandatory cost of living adjustments, which compensate Israeli
      employees for a portion of the increase in the Israeli consumer price index,
      are
      determined on a nationwide basis. Israeli law also requires the payment of
      severance benefits upon the termination, retirement or death of an employee.
      We
      meet this requirement, inter alia, by contributing on an ongoing basis towards
      “managers’ insurance” and pension funds. In addition, Israeli employers and
      employees are required to pay specified percentages of wages to the National
      Insurance Institute, which is similar/compatible with the United States Social
      Security Administration. Other provisions of Israeli law and regulations govern
      matters such as the length of the workday, minimum wages, other terms of
      employment and restrictions on discrimination. We are also subject to the labor
      laws and regulations of other jurisdictions in the world where we have
      employees.




**E.**
            **Share
                Ownership**




The
      following presents information regarding the ownership of our ordinary shares
      by
      the persons listed in the table under “Directors and Senior Management,” as of
      March 26, 2008. The percentage of outstanding ordinary shares is based on
      20,907,929 ordinary shares outstanding as of March 26, 2008 (excluding 1,647,594
      shares held by two of our wholly owned subsidiaries).




Unless
      otherwise specifically indicated, the address of each of the persons set forth
      below is at c/o BluePhoenix, 8 Maskit Street, Herzliya 46733.




**Name**
            
            **Number
                of**
              **shares**
              **beneficially**
              **owned**(1)
            
            **Percentage
                of outstanding**
              **ordinary**
              **shares**
            
            **Number
                of**
              **Restricted**
              **Share
                Units**
              **(RSUs)**
            
            **Number
                of**
              **options
                to**
              **purchase**
              **ordinary**
              **shares**Arie
                Kilman(2)
            
            
            574,999
            
            
            6.0
            %
            
            20,000
            
            
            725,000(1
            )Varda
                Sagiv(3)
            
            
            -
            
            
            -
            
            
            16,667
            
            
            -Eliezer
                Harkavi(4)
            
            
            -
            
            
            -
            
            
            23,000
            
            
            16,000David
                Leichner(5)
            
            
            7,500
            
            
            *
            
            
            22,500
            
            
            -Yossi
                Shemesh(6)
            
            
            -
            
            
            -
            
            
            50,000
            
            
            75,910Yael
                Peretz(7)
            
            
            7,500
            
            
            *
            
            
            15,000
            
            
            2,500Greg
                Schottland(8)
            
            
            -
            
            
            -
            
            
            10,500
            
            
            -Tom
                O’Connell
            
            
            -
            
            
            -
            
            
            -
            
            
            -Pesach
                Gal-On(9)
            
            
            -
            
            
            -
            
            
            -
            
            
            75,000Tzvia
                Shmuelevitz(10)
            
            
            -
            
            
            -
            
            
            3,000
            
            
            75,000Shai
                Beilis(11)
            
            
            1,333
            
            
            *
            
            
            2,667
            
            
            -Michael
                Chill
            
            
            -
            
            
            -
            
            
            -
            
            
            -Amira
                Berkovitz-Amir(12)
            
            
            -
            
            
            -
            
            
            2,667
            
            
            -All
                directors and officers as a group (13 persons)(13)
            
            
            1,510,742
            
            
            10.7
            %
            
            166,001
            
            
            969,410


______________


*
      Less
      than 1%.


68





(1)
            Each
                of the directors and executive officers whose holdings are not separately
                specified in the above table beneficially owns less than one percent
                of
                our outstanding ordinary shares. Options to purchase ordinary shares
                that
                are currently exercisable or exercisable within 60 days after the
                date of
                this report are deemed outstanding and beneficially owned by the
                person
                holding the options for the purpose of computing the percentage ownership
                of that person, but are not treated as outstanding for the purpose
                of
                computing the percentage ownership of any other person.******


(2)
            Mr.
                Kilman was granted options to purchase ordinary shares under the
                following
                terms: (i) currently exercisable options to purchase 375,000 ordinary
                shares at $2.25 per share, which expire in April 2013; (ii) currently
                exercisable options to purchase 200,000 ordinary shares exercisable
                at
                $4.00 per share, which expire in September 2013; and (iii) currently
                exercisable options to purchase 150,000 ordinary shares at $6.00
                per
                share, which expire in September 2015. In addition, Mr. Kilmanwas
                granted RSUs, of which: (i) 10,000 RSUs are convertible into ordinary
                shares in January 2009; and (ii) 10,000 RSUs are convertible into
                ordinary
                shares in January 2010.


(3)
            Ms.
                Sagiv was granted RSUs under the following terms:(i)
                8,333 RSUs are convertible into ordinary shares in August 2009; and
                (ii)
                8,334 RSUs are convertible into ordinary shares in August
                2010.


(4)
            Mr.
                Harkavi was granted options to purchase 16,000 ordinary shares exercisable
                at $5.00 per share which are currently exercisable and expire in
                December
                2015. In addition, Mr. Harkavi was granted RSUs under the following
                terms:
                (i) 5,333 RSUs are convertible into ordinary shares in August 2008;
                (ii)
                5,333 RSUs are convertible into ordinary shares in August 2009; and
                (iii)
                5,334 RSUs are convertible into ordinary shares in August
                2010.


(5)
            Of
                the RSUs granted to Mr. Leichner: (i) 7,500 RSUs are convertible
                into
                ordinary shares in August 2008; (ii) 7,500 RSUs are convertible into
                ordinary shares in August 2009; and (iii) 7,500 RSUs are convertible
                into
                ordinary shares in August 2010.


(6)
            Mr.
                Shemesh was granted options to purchase ordinary shares under the
                following terms: (i) currently exercisable options to purchase 60,910
                ordinary shares at $3.00 per share, which expire in April 2013; and
                (ii)
                currently exercisable options to purchase 15,000 ordinary shares
                exercisable at $5.00 per share, which expire in September 2015. In
                addition, Mr. Shemesh was grantedRSUs
                under the following terms: (i) 7,666 RSUs are convertible into ordinary
                shares in August 2008; (ii) 9,000 RSUs are convertible into ordinary
                shares in October 2008; (iii) 7,666 RSUs are convertible into ordinary
                shares in August 2009; (iv) 9,000 RSUs are convertible into ordinary
                shares in October 2009; (v) 7,667 RSUs are convertible into ordinary
                shares in August 2010; and (vi) 9,000 RSUs are convertible into ordinary
                shares in October 2010.


(7)
            Ms.
                Peretz was granted currently exercisable options to purchase 2,500
                ordinary shares at $5.00 per share, which expire in December 2015.
                In
                addition, Ms. Peretz was grantedRSUs,
                of which: (i) 5,000 RSUs are convertible into ordinary shares in
                August
                2008; (ii) 5,000 RSUs are convertible into ordinary shares in August
                2009;
                and (iii) 5,000 RSUs are convertible into ordinary shares in August
                2010.


(8)
            Mr.
                Schotland was granted RSUs under the following terms: (i) 2,666 RSUs
                are
                convertible into ordinary shares in August 2008; (ii) 833 RSUs are
                convertible into ordinary shares in February 2009; (iii) 2,667 RSUs
                are
                convertible into ordinary shares in August 2009; (iv) 833 RSUs are
                convertible into ordinary shares in February 2010; (v) 2,667 RSUs
                are
                convertible into ordinary shares in August 2010; and (vi) 834 RSUs
                available for sale in February
                2011.


(9)
            Mr.Gal-Onwas
                granted options to purchase ordinary shares under the following terms:
                (i)
                currently exercisable options to purchase 50,000 ordinary shares
                at $4.00
                per share, which expire in December 2015; and (ii) options to purchase
                25,000 ordinary shares at $4.00 per share, which vest in December
                2008 and
                expire in September 2015.


(10)
            Ms.
                Shmuelevitz was granted options to purchase ordinary shares under
                the
                following terms: (i) currently exercisable options to purchase 50,000
                ordinary shares at $4.00 per share, which expire in December 2015;
                (ii)
                options to purchase 25,000 ordinary shares at $4.00 per share, which
                vest
                in December 2008 and expire in September 2015. In addition, Ms.
                Shmuelevitz was grantedRSUs
                under the following terms: (i) 1,000 RSUs are convertible into ordinary
                shares in August 2009; (ii) 1,000 RSUs are convertible into ordinary
                shares in August 2009; and (iii) 1,000 RSUs are convertible into
                ordinary
                shares in August 2010.


(11)
            Mr.
                Beilis was granted RSUs, of which: (i) 1,333 RSUs are convertible
                into
                ordinary shares in January 2009; and (ii) 1,334 RSUs are convertible
                into
                ordinary shares in January 2010.


(12)
            Ms.
                Berkovitz-Amir was granted RSUs under the following terms: (i) 1,333
                RSUs
                are convertible into ordinary shares in January 2009; and (ii) 1,334
                RSUs
                are convertible into ordinary shares in January
                2010.


(13)
            Includescurrently
                exercisable options to purchase 919,410 ordinary shares, held by
                our
                directors and officers.


69





***Arrangements
      Involving the Issuance of BluePhoenix’s Shares or Grant of Options to Purchase
      Shares***




In
      1996,
      we adopted two option plans. One of these option plans was terminated after
      all
      options granted under it had been exercised. **** Pursuant
      to our other 1996 option plan, as amended, we reserved 3,700,000 ordinary shares
      for issuance to our and our subsidiaries’ directors, officers, consultants and
      employees. As of March 26, 2008, options to purchase 1,300,628 ordinary
      shares were outstanding under the plan. The exercise price of the options
      granted under the 1996 option plan ranges from $2.25 to $10.50.





Our
      board
      of directors administers our 1996 option plan. Under the 1996 option plan,
      as
      amended, options to purchase our ordinary shares may be granted to our and
      our
      subsidiaries’ directors, officers, consultants and employees. Our board of
      directors is empowered, among other things, to designate the grantees, dates
      of
      grant, the exercise price of the options and the terms of exercise of the
      options. Unless determined otherwise by the board, the options generally vest
      over a three-year period. Unvested options are forfeited shortly following
      termination of employment, unless otherwise agreed. Under the 1996 option plan,
      the grantee is responsible for all personal tax consequences of the grant and
      the exercise of the options. Each option granted under the 1996 option plan
      is
      exercisable during a term of ten years from the date of grant of the option.
      The
      1996 option plan will expire on August 6, 2013, except as to options outstanding
      on that date.





In
      anticipation of the effect of the adoption of SFAS
      123(R) ,
      and
      under the management belief that in the currently increasing competition in
      the
      labor market, an acceleration may have a positive effect on employee morale
      and
      retention, our board of directors and compensation committee approved as of
      December 27, 2005, the acceleration of several outstanding unvested options
      under our 1996 option plan so as to be fully-vested as of such date (see Notes
      1K and 11B(1) to our financial statements). As a result, options to purchase
      144,900 BluePhoenix ordinary shares and options to purchase 1,228,997 shares
      of
      Mainsoft, were accelerated. The acceleration of options held by our officers,
      who also serve as directors of the company, was also approved by the company’s
      shareholders as required under the law.





In
      July
      2007, we adopted an award plan, referred to as the 2007 Award Plan, under which
      our board of directors may grant conditional rights to receive BluePhoenix
      ordinary shares (RSUs) to our and our subsidiaries’ directors, officers,
      consultants and employees. Our board of directors approved the issuance of
      the
      shares under the 2007 Award Plan and award agreements. As of March 26, 2008,
      we
      granted 247,500 RSUs under the plan. Our board of directors administers the
      plan
      and is empowered, among other things, to designate the grantees, dates of grant,
      the purchase price and the terms of RSUs, including the vesting schedule.
      Unvested RSUs are forfeited following termination of employment, unless
      otherwise agreed. Under the 2007 Award Plan, the grantee is responsible for
      all
      personal tax consequences of the grant and the sale of the shares. The plan
      will
      expire on 2017.


70




**ITEM
      7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS**




**A.**  **Major
      Shareholders** ****





The
      following table presents information regarding the ownership of our ordinary
      shares at March 26, 2008 by each person known to us to be the beneficial owner
      of 5% or more of our ordinary shares. Options to purchase ordinary shares that
      are currently exercisable or exercisable within 60 days after the date of this
      report are deemed outstanding and beneficially owned by the person holding
      the
      options for the purpose of computing the percentage ownership of that person,
      but are not treated as outstanding for the purpose of computing the percentage
      ownership of any other person. Except where we indicated otherwise, we believe,
      based on information furnished by these owners, that the beneficial owners
      of
      our shares listed below have sole investment and voting power with respect
      to
      the shares.




**Name
                and Address**
            
            **Number of
                Ordinary Shares****Owned**
            
            **Percent of Total**
              **Shares****(1)**Arie
                Kilman(2)
              BluePhoenix
                Solutions Ltd.
              8
                Maskit Street, Herzliya, Israel 46733
            
            
            1,299,999
            
            
            6.01
            %Systematic
                Financial Management, L.P.(3)
            
            
            1,191,231
            
            
            5.8
            %Gilder,
                Gagnon, Howe & Co. LLC(4)
            
            
            2,555,019
            
            
            12.5
            %All
                directors and officers as a group (13 persons)(5)
            
            
            1,510,742
            
            
            6.73
            %


____________


(1)  Percentages
      in the above table are based on 20,907,929 ordinary shares outstanding as of
      March 26, 2008 and do not include 1,647,594 ordinary shares held by two of
      our
      wholly owned subsidiaries. Pursuant to Israeli law, these shares do not confer
      upon our subsidiaries any voting rights (although such shares entitle their
      holders to participation rights upon distribution).





(2)  Number
      of
      shares owned includes options currently exercisable to purchase 725,000 Ordinary
      Shares.





(3)  Based
      on
      a Schedule 13G filed on February 19, 2008. Systematic Financial Management
      L.P.
      is located at 300 Frank W. Burr Blvd., Glenpointe East, 7th Floor, Teaneck,
      NJ
      07666.





(4)  Based
      on
      a Schedule 13G (Amendment No. 2) filed on February 6, 2008. 2,282,478 of the
      above shares are held in customer accounts over which the partners and/or
      employees of Gilder, Gagnon, Howe & Co. LLC, referred to as GGH, have
      discretionary authority to dispose of or direct the disposition of the shares,
      234,116 of the shares are held in accounts owned by the partners of GGH and
      their families and 38,425 shares are held in the account of the profit-sharing
      plan of GGH. GGH is located at 1775 Broadway, 26 th floor,
      New York, NY 10019.





(5)  Includes
      currently exercisable options to purchase 919,410 ordinary shares, held by
      certain of our directors and officers.





On
      June
      19, 2007, Formula Systems (1985) Ltd., our former controlling shareholder,
      sold
      its entire interest in BluePhoenix to several international institutional
      investors.





All
      of
      our ordinary shares have equal voting rights. Under our two buy-back programs
      (as described in “Item 5.B. Liquidity and Capital Resources” above), two of our
      subsidiaries purchased 1,870,565 of our ordinary shares, of which 136,000 shares
      were sold in January 2006 to Israeli institutional investors in Israel and
      86,971 shares were sold in February 2006 to Outlook Systems Ltd. Under
      applicable Israeli law, so long as the shares are held by our subsidiaries,
      they
      have no voting rights but such shares confer upon their holder’s participation
      rights upon distribution.


71





As
      of March 26, 2008, there were 33 record holders of our ordinary
      shares. Of these record holders, 23 holders had mailing addresses in the
      United States owning an aggregate less than 1% of our outstanding ordinary
      shares, excluding the shares that our subsidiaries hold.





**B.**
            **Related
                Party Transactions******





*Management
      Agreement with Formula*





From
      January 1996 and until June 2007, Formula Systems (1985) Ltd., referred to
      as
      Formula, at that time our parent company provided us with administrative and
      management support, pursuant to a letter agreement dated January 1, 1996.
      Pursuant to the letter agreement, we paid Formula in return for its services,
      a
      management fee equal to 3.0% of our revenues, up to a maximum of $180,000 per
      year. In addition, we used to reimburse Formula from time to time for expenses
      Formula incurred on our behalf. The agreement was terminated on June 19, 2007,
      when Formula sold its entire interest in BluePhoenix. The amount of management
      fee was negotiated in 1996 when we initially entered into the letter agreement.
      The amount of the fee was determined primarily on the parties’ good faith
      estimates of the value of services to be provided by the three directors
      seconded to us by Formula and the extent of our expected cost savings to be
      generated by Formula’s assistance in obtaining volume discounts and the
      provision of administrative support. Although we did not engage in actual
      negotiations with potential third-party providers of comparable services, the
      fee was based in part on our market knowledge of the cost of obtaining such
      services from third parties and/or developing the internal resources necessary
      to carry out these functions ourselves.





*Payment
      by Formula to Our Chief Executive Officer*





** In
      June
      2007, Formula, our former controlling shareholder, has paid a bonus of $1.8
      million to Mr. Kilman, our chief executive officer, as compensation with respect
      to the sale by Formula of its shareholding in BluePhoenix.





*Transactions
      Between Us and Our Subsidiaries*





We
      currently hold 40% of the outstanding share capital of MultiConn Technologies
      and have an option to increase our holdings in MultiConn Technologies to 60%.
      As
      of March 26, 2008, we lent to MultiConn Technologies an aggregate amount of
      $2.5
      million.





In
      2000,
      we entered into a management agreement with Mainsoft, under which we provide
      Mainsoft with management and advisory consulting services. Until the end of
      2005, Mainsoft paid us in exchange for our services aggregate consideration
      of
      $120,000 per year. Beginning with 2006, the management fees were reduced to
      $60,000 per year.




In
      February 2005, we entered into an alliance agreement with Zulu for cooperation
      in marketing and selling Zulu’s and our software tools and services. For more
      information about Zulu, see “Item 4.B. Business Overview–Investments and
      Acquisitions-Zulu.”


72





*Indemnification
      of Office Holders*





Since
      July 2003, we grant to our office holders’ indemnification letters covering acts
      performed in their capacity as office holders or employees of our company. In
      December 2005, our shareholders approved an amendment to those indemnification
      letters, following an amendment to the Companies Law. Pursuant to the amended
      indemnification letters, we undertake to indemnify each office holder to the
      maximum extent permitted by law in respect of the following for any act or
      omission taken or made by the office holder in his or her capacity as an office
      holder of our company:




·
            any
                financial obligation imposed on the office holder in favor of another
                person by a court judgment, including a settlement or an arbitrator’s
                award approved by court,




·
            all
                reasonable litigation expenses, including attorney’s fees, expended by the
                office holder as a result of an investigation or proceeding instituted
                against the office holder by a competent authority, provided that
                such
                investigation or proceeding concluded without the filing of an indictment
                against the office holder and either (a) concluded without the imposition
                of any financial liability in lieu of criminal proceedings; or (b)
                concluded with the imposition of a financial liability in lieu of
                criminal
                proceeding but relates to a criminal offense that does not require
                proof
                of*mens
                rea*(criminal
                intent); and




·
            all
                reasonable litigation expenses, including attorney’s fees, expended by the
                office holder or charged to him or her by a court in a proceeding
                instituted against the office holder by us or on our behalf or by
                another
                person, or in any criminal proceedings in which the office holder
                is
                acquitted, or in any criminal proceedings of a crime that does not
                require
                proof of*mens
                rea*(criminal intent) in which the office holder is
                convicted.





The
      indemnification also applies to any action taken by the office holder in respect
      of an act performed in his or her capacity as an office holder or an employee
      of
      one of our subsidiaries or as a director or observer at board of directors’
meetings of one of our affiliates. Our undertaking for indemnification is
      limited to up to 25% of our shareholders’ equity at the time of the claim for
      indemnification.





Our
      undertaking for indemnification does not apply to a liability incurred as a
      result of any of the following:




·
            a
                breach by the office holder of his or her duty of loyalty, unless,
                to the
                extent permitted by law, the office holder acted in good faith and
                had
                reasonable cause to assume that such act would not prejudice the
                interests
                of our company;




·
            a
                willful breach by the office holder of his or her duty of care, unless
                such breach was solely due to
                negligence;




·
            an
                action taken or not taken with the intent of unlawfully realizing
                personal
                gain;




·
            a
                fine or penalty imposed on the office holder for an offense;
                and




·
            a
                counterclaim made by us in connection with a claim against us filed
                by the
                office holder.


73




Our
      undertaking for indemnification is limited to such events specified in the
      indemnification letter and determined by our board of directors to be
      foreseeable in light of the company’s operations.





Under
      the
      indemnification letters, we exempt our office holders to the fullest extent
      permitted by law, from liability for damages caused as a result of a breach
      by
      the office holder of his or her duty of care to the company.




*Office
      Holders Insurance*





We
      procured an insurance policy covering our directors’ and officers’ liability.
      Our subsidiaries participate in the premium payments of the insurance, on a
      proportional basis. The total premium we paid during 2007 was $305,000,
      including a run-off policy for 7 years for former directors and
      officers.




**C.**
            **Interests
                of Expert and Counsel**





Not
      applicable.


74




**ITEM
      8. FINANCIAL INFORMATION**




**A.**
            **Consolidated
                Statements and Other Financial
                Information**





***Financial
      Statements***





The
      financial statements required by this item are found at the end of this annual
      report, beginning on page F-1.





***Legal
      Proceedings***




We
      are
      not involved in any proceedings in which any of our directors, members of our
      senior management or any of our affiliates is either a party adverse to us
      or to
      our subsidiaries or has a material interest adverse to us or to our
      subsidiaries. We are also not involved in any material legal proceedings, except
      as described below.




In
      July
      2003, a former Liraz shareholder filed an application with the Tel Aviv, Jaffa
      District Court to approve a claim filed by him against us, as a class action.
      The claim relates to the acquisition of Liraz shares, which we completed in
      March 2003. The shareholder alleges that the share price we paid to Liraz’s
      shareholders in the tender offer and in a subsequent mandatory purchase was
      lower than the fair price of Liraz shares. The maximum amount of the claim
      is
      approximately $8.6 million in the aggregate. Under Israeli law, the court’s
      approval is required for the plaintiff to represent all of the shareholders
      of
      Liraz who sold their shareholdings to us pursuant to the tender offer and the
      mandatory acquisition. The plaintiff has applied for such approval in the
      lawsuit. Based on our analysis of the statement of claim, including an
      evaluation of the fair value of the Liraz shares, and the price paid for Liraz
      in a previous transaction immediately prior to the tender offer, we believe
      that
      the allegations against us in this proceeding are without merit and we intend
      to
      vigorously defend the claim and contest the allegations made therein .




***Dividend
      policy***




We
      have
      never declared or paid dividends to our shareholders and we do not intend to
      pay
      dividends in the future. We anticipate that we will retain all of our future
      earnings for use in the expansion and operation of our business. We are not
      subject to any contractual restrictions on paying dividends. Any future
      determination relating to our dividend policy will be made at the discretion
      of
      our board of directors and will depend on a number of factors, including our
      future earnings, capital requirements, financial condition, future prospects
      and
      other factors as the board of directors may deem relevant. Israeli law limits
      the distribution of cash dividends to the greater of retained earnings or
      earnings generated over the two most recent years, in either case provided
      that
      we reasonably believe that the dividend will not render us unable to meet our
      current or foreseeable obligations when due.




**B.**
            **Significant
                Changes******




Except
      as
      otherwise disclosed in this annual report, there has been no material change
      in
      our financial position since December 31, 2007.


75




**ITEM
      9. THE OFFER AND LISTING**




**A.**
            **Offer
                and Listing Details******





The
      following table shows the high and low closing price for our ordinary shares
      on
      the NASDAQ Global Market for the periods indicated.


**Calendar
                  Period**
              
              **Closing
                  Price Per Share In US$****High**
              
              **Low****Annual****2003**
              
              
              7.04
              
              
              2.10**2004**
              
              
              7.49
              
              
              3.92**2005**
              
              
              4.75
              
              
              3.81**Fiscal
                  Quarters****2006**
              
              
              6.45
              
              
              3.85First
                  Quarter
              
              
              5.23
              
              
              3.85Second
                  Quarter
              
              
              5.61
              
              
              4.90Third
                  Quarter
              
              
              5.70
              
              
              4.60Fourth
                  Quarter
              
              
              6.45
              
              
              5.16**2007**
              
              
              21.49
              
              
              5.94First
                  Quarter
              
              
              7.10
              
              
              5.94Second
                  Quarter
              
              
              11.89
              
              
              6.62Third
                  Quarter
              
              
              18.41
              
              
              11.30Fourth
                  Quarter
              
              
              21.49
              
              
              14.82**Most
                  Recent Six Months**September
                  2007
              
              
              18.41
              
              
              15.54October
                  2007
              
              
              21.49
              
              
              16.98November
                  2007
              
              
              21.29
              
              
              14.82December
                  2007
              
              
              18.94
              
              
              15.57**2008**January
                  2008
              
              
              20.66
              
              
              14.91February
                  2008
              
              
              13.66
              
              
              9.24March
                  (through March 26)
              
              
              9.25
              
              
              7.25


76





The
      following table shows the high and low closing price for our ordinary shares
      on
      the TASE for the periods indicated.




**Calendar
                  Period**
              
              **Closing
                  Price Per Share In NIS****High**
              
              **Low****Annual****2003**
              
              
              29.20
              
              
              11.49**2004**
              
              
              34.48
              
              
              17.00**2005**
              
              
              20.99
              
              
              16.01**Fiscal
                  Quarters****2006**
              
              
              26.88
              
              
              17.41First
                  Quarter
              
              
              23.99
              
              
              17.41Second
                  Quarter
              
              
              26.88
              
              
              23.15Third
                  Quarter
              
              
              25.20
              
              
              20.62Fourth
                  Quarter
              
              
              26.88
              
              
              23.32**2007**
              
              
              85.51
              
              
              25.69First
                  Quarter
              
              
              29.27
              
              
              25.69Second
                  Quarter
              
              
              50.32
              
              
              27.49Third
                  Quarter
              
              
              73.68
              
              
              48.00Fourth
                  Quarter
              
              
              85.51
              
              
              59.02**Most
                  Recent Six Months**September
                  2007
              
              
              73.68
              
              
              62.65October
                  2007
              
              
              85.51
              
              
              70.72November
                  2007
              
              
              83.67
              
              
              59.02December
                  2007
              
              
              75.05
              
              
              62.48**2008**January
                  2008
              
              
              74.83
              
              
              61.68February
                  2008
              
              
              48.50
              
              
              33.60March
                  (through March 26)
              
              
              36.04
              
              
              24.68




The
      following table shows the high and low closing price for our series A
      convertible notes on the TASE for the periods indicated. Trading in the notes
      was stopped on February 19, 2008 when the notes were delisted from the
      TASE.




**Calendar
                Period**
            
            **Price
                Per note****High**
            
            **Low****(in
                NIS)****Annual****Fiscal
                quarters****2006**
            
            
            1.090
            
            
            1.020First
                quarter (from February 12)
            
            
            1.074
            
            
            1.020Second
                quarter
            
            
            1.090
            
            
            1.073Third
                quarter
            
            
            1.073
            
            
            1.030Fourth
                quarter
            
            
            1.065
            
            
            1.054**2007**
            
            
            3.280
            
            
            1.050First
                quarter
            
            
            1.120
            
            
            1.050Second
                quarter
            
            
            1.960
            
            
            1.076Third
                quarter
            
            
            2.880
            
            
            1.900Fourth
                quarter
            
            
            3.280
            
            
            2.390**Most
                Recent Six Months**September
                2007
            
            
            2.880
            
            
            2.430October
                2007
            
            
            3.280
            
            
            2.710November
                2007
            
            
            3.200
            
            
            2.450December
                2007
            
            
            2.830
            
            
            2.390**2007**January
                2008
            
            
            2.840
            
            
            2.540February
                2008 (through February 19)
            
            
            2.710
            
            
            1.499


77




**B.**
            **Plan
                of Distribution**




Not
      applicable.




**C.**  **Markets**




Our
      ordinary shares have been traded in the United States on the NASDAQ Global
      Market since our initial public offering on January 30, 1997 and were not
      publicly traded prior to this date. The symbol on the NASDAQ Global Market
      for
      our ordinary shares is BPHX. On January 21, 2001, we listed our ordinary shares
      for trading on the TASE.




Our
      series A convertible notes were traded on the TASE from February 12, 2006 and
      until February 19, 2008.




Pursuant
      to Marketplace Rule 4350(a) of NASDAQ, we received a permanent exemption from
      Marketplace Rule 4350(b)(1)(A), which requires a company to distribute to its
      shareholders copies of its annual report containing its audited financial
      statements. We follow the common practice among TASE companies, and do not
      send
      our annual financial statements to shareholders.  A
      copy of
      our annual report on Form 20-F is posted on our website promptly after it is
      filed with the SEC and the TASE.




In
      addition, pursuant to NASDAQ Marketplace Rule 4350(a), we notified NASDAQ that
      with respect to the following, we follow Israeli law and practice and
      accordingly do not following NASDAQ rules:




·
            in
                lieu of the requirements specified in NASDAQ Marketplace Rule 4350(c)(2)
                requiring that independent directors have regularly scheduled meetings
                at
                which only independent directors are present;
                and




·
            in
                lieu of the requirements specified in NASDAQ Marketplace Rule 4350(c)(1),
                which requires the majority of the board of directors to be comprised
                of
                independent directors.




Moreover,
      under Israeli law, we do not need shareholder approval for establishment of
      a
      stock option or purchase plans, and therefore we did not seek shareholder
      approval for establishment of our new restricted share units plan adopted in
      2007.




**D.**
            **Selling
                Shareholders**




Not
      applicable.




**E.**
            **Dilution**




Not
      applicable.




**F.**
            **Expenses
                of the Issue**




Not
      applicable.


78




**ITEM
      10. ADDITIONAL INFORMATION**




**A.**
            **Share
                Capital**




Not
      applicable.




**B.**
            **Memorandum
                and Articles of
                Association**




We
      are
      registered with the Israeli Companies Register under the number 52-004306-8.
      Our
      objects are specified in our memorandum of association. These objects include:




·
            operating
                within the field of informational and computer
                systems;


·
            providing
                management, consulting and sale services for computers, computer
                equipment, software for computers and for information
                systems;


·
            the
                business of systems analysis, systems programming and computer
                programming; and


·
            establishing
                facilities for instruction and training for computers and digital
                systems.




***Description
      of Our Share Capital***




Our
      company share capital consists of ordinary shares. Our articles of association
      do not restrict in any way the ownership of our ordinary shares by nonresidents,
      except that these restrictions may exist with respect to citizens of countries
      that are in a state of war with Israel.




***Transfer
      of Shares***




Fully
      paid ordinary shares are issued in registered form and may be freely transferred
      under our articles of association unless the transfer is restricted or
      prohibited by another instrument.




***Modification
      of Class Rights***




Under
      our
      articles of association, the rights attached to any class unless otherwise
      provided by the terms of the class, including voting, rights to dividends and
      the like, may be varied by adoption of the necessary amendment to the articles
      of association, provided that the affected shareholders approve the change
      by a
      class meeting in which a simple majority of the voting power of the class
      represented at the meeting and voting on the matter approves the
      change.




***Dividend
      Rights and Liquidation Rights***




We
      may
      declare a dividend to be paid to the holders of ordinary shares according to
      their rights and interests in our profits. We may pay the dividend as an
      allotment of shares or a distribution of assets. If we do decide to issue
      dividends by an allotment of shares at a price lower than the nominal value
      of
      those shares, we must convert a portion of our profits or any other source
      of
      equity to share capital in an amount equal to the difference between the nominal
      value of the shares and the price paid in the dividend. If dividends remain
      unclaimed for seven years from the date we declared the dividend, they lapse
      and
      revert back to us. In case of liquidation, after satisfying liabilities to
      creditors, our assets will be distributed to the holders of ordinary shares
      in
      proportion to their holdings. This right may be affected by the grant of a
      preferential dividend or distribution rights to the holders of a class of shares
      with preferential rights that may be authorized in the future.


79





***Redemption
      provisions***





In
      accordance with our articles of association, we may issue redeemable shares
      and
      accordingly redeem those shares. Our board may attach to redeemable shares
      the
      attributes of shares, including voting rights and the right to participate
      in
      profits.





***Voting,
      Shareholder Meetings and Resolutions***





Holders
      of our ordinary shares have one vote for each ordinary share held on all matters
      submitted to the vote of shareholders. These voting rights may be affected
      by
      the grant of any special voting rights to the holders of a class of shares
      with
      preferential rights that may be authorized in the future.





We
      must
      hold an annual general meeting once a year with a maximum period of fifteen
      months between the meetings. All other meetings of shareholders other than
      annual general meetings are considered special general meetings. Our board
      of
      directors may, whenever it decides it is appropriate, and shall, within 21
      days
      after receiving a written demand from one director or from one or more
      shareholders representing at least 10% of the outstanding share capital and
      1%
      of the voting power, call a special general meeting. The quorum required for
      a
      general meeting of shareholders consists of two or more holders present in
      person or by proxy who hold or represent at least 35% of the voting power.
      A
      meeting adjourned for a lack of a quorum generally is adjourned to the same
      day
      in the following week at the same time and place or to another later time if
      such time is specified in the original notice convening the general meeting
      or
      if we give notice to the shareholders of another time at least 72 hours before
      the date fixed for the adjourned meeting. At the reconvened meeting, if a quorum
      is not present within half an hour from the time appointed for holding the
      meeting, the required quorum will consist of two shareholders present in person
      or by proxy.





Under
      the
      Companies Law, unless otherwise provided in the articles of association or
      applicable law, all resolutions of the shareholders require a simple majority,
      except in certain circumstances provided for under the Companies Law, which
      require a majority of at least 75% of the shares present at the meeting. In
      accordance with the Companies Law, all shareholders meetings require prior
      notice of at least 21 days. In some instances specified in regulations
      promulgated under the Companies Law, a 35-day prior notice should be given
      of a
      shareholders meeting.





Under
      the
      Companies Law, a shareholder has a duty to act in good faith towards the company
      in which he holds shares and towards other shareholders and to refrain from
      abusing his power in the company including voting in the general meeting of
      shareholders on:





·
            any
                amendment to the articles of
                association;


·
            an
                increase of the company’s authorized share
                capital;


·
            a
                merger; or


·
            approval
                of some of the acts and transactions that require shareholder
                approval.


80





A
      shareholder has the general duty to refrain from depriving rights of other
      shareholders. Any controlling shareholder, any shareholder who knows that it
      possesses the power to determine the outcome of a shareholder vote and any
      shareholder that, under the provisions of the articles of association, has
      the
      power to appoint an office holder in the company, is under a duty to act in
      fairness towards the company. The Companies Law does not describe the substance
      of this duty.





***Election
      of Directors***





Our
      ordinary shares do not have cumulative voting rights in the election of
      directors. As a result, the holders of ordinary shares that represent more
      than
      50% of the voting power represented at a shareholders meeting have the power
      to
      elect all of our directors, other than the outside directors that are appointed
      by a special majority of shareholders. For a summary of those provisions in
      our
      articles of association with respect to the directors, see “Item 6. Directors,
      Senior Management, and Employees.”





***Anti-Takeover
      Provisions; Mergers and Acquisitions under Israeli
      Law***





*Mergers*





The
      Companies Law includes provisions that allow a merger transaction and requires
      that each company that is party to a merger approve the transaction by its
      board
      of directors and a vote of the majority of its shares voting on the proposed
      merger at a shareholders’ meeting called on at least 21 days’ prior notice. In
      determining whether a majority has approved the merger, shares held by the
      other
      party to the merger or any person holding at least 25% of the other party to
      the
      merger are excluded from the vote. The Companies Law does not require court
      approval of a merger other than in specified situations. Upon the request of
      a
      creditor of either party to the proposed merger, the court may delay or prevent
      the merger if it concludes that there exists a reasonable concern that as a
      result of the merger, the surviving company will be unable to satisfy the
      obligations of any of the parties to the merger. In addition, a merger may
      not
      be completed unless at least (i) 30 days have passed from the date of the merger
      approval by the shareholders of each of the merging companies; and (ii) 50
      days
      have passed from the time that a proposal for approval of the merger has been
      filed with the Israeli registrar of companies.





*Tender
      Offers*





The
      Companies Law also provides that an acquisition of shares of a public company
      on
      the open market must be made by means of a tender offer if as a result of the
      acquisition the purchaser would become a 25% shareholder of the company. The
      rule does not apply if there is already another 25% shareholder of the company.
      Similarly, the Companies Law provides that an acquisition of shares in a public
      company must be made by means of a tender offer if, as a result of the
      acquisition, the purchaser would become a 45% shareholder, unless there is
      a
      shareholder holding at least 45% interest in the company. These rules do not
      apply if the acquisition is made by way of a merger as opposed to a tender
      offer.


81





Regulations
      adopted under the Companies Law provide that these tender offer requirements
      do
      not apply to companies whose shares are listed for trading outside of Israel
      if,
      according to the law in the country in which the shares are traded, including
      the rules and regulations of the stock exchange on which the shares are traded,
      there is either a limitation on acquisition of any level of control of the
      company, or the acquisition of any level of control requires the purchaser
      to do
      so by means of a tender offer to the public. The Companies Law also provides
      that if following any acquisition of shares, the acquirer holds 90% or more
      of
      the company’s shares or of a class of shares, the acquisition must be made by
      means of a tender offer for all the target company’s shares or all the shares of
      the class, as applicable. An acquirer who wishes to eliminate all minority
      shareholders must do so by way of a tender offer and acquire 95% of all shares
      not held by or for the benefit of the acquirer before the acquisition. If,
      however, the tender offer to acquire 95% is not successful, the acquirer may
      not
      acquire shares tendered if by doing so the acquirer would own more than 90%
      of
      the shares of the target company.




**C.**
            **Material
                Contracts**





We
      consider the agreements related to the $35 million private placement of shares
      and warrants completed in November 2007, the purchase agreement of BridgeQuest,
      the purchase agreement of ASNA and the purchase agreement with CodeStream,
      as
      material contracts. For a summary of the terms of these transactions, see “Item
      4.B. Business Overview - Investments and Acquisitions” and “Item 5.B. Liquidity
      and Capital Resources.” In addition, the agreement with SDC Udvikling described
      below is material to our business.





*Services
      Agreement with SDC Udvikling*





In
      October 2002, we entered into a services agreement with an affiliated company
      of
      SDC, named SDC Udvikling A/S, for the provision of IT development services
      related to our tool, AppBuilder. Under the agreement, SDC Udvikling has been
      purchasing from us various services pursuant to specific amendments to the
      agreement and purchase orders signed from time to time. SDC Udvikling accounted
      for 12% and 11% of our revenues in 2007 and 2006, respectively.




**D.**
            **Exchange
                Controls**





Under
      current Israeli regulations, we may pay dividends or other distributions in
      respect of our ordinary shares either in non-Israeli or Israeli currencies.
      If
      we make these payments in Israeli currency, they will be freely transferred
      in
      non-Israeli currencies at the rate of exchange prevailing at the time of
      conversion. Because exchange rates between the NIS and the dollar fluctuate
      continuously, a U.S. shareholder will be subject to the risk of currency
      fluctuations between the date when we declare NIS-denominated dividends and
      the
      date when we pay them in NIS. See “Item 3.D. Risk Factors.”





Nonresidents
      of Israel may freely hold and trade our securities pursuant to the general
      permit issued under the Israeli Currency Control Law, 1978. Neither our
      memorandum of association nor the laws of the State of Israel restrict in any
      way the ownership of our ordinary shares by nonresidents, except that these
      restrictions may exist with respect to citizens of countries that are in a
      state
      of war with Israel.


82




**E.**
            **Taxation******





***Israeli
      Taxation***





The
      following is a description of material tax consequences regarding the ownership
      and disposition of our ordinary shares under Israeli tax laws to which U.S.
      and
      other non-Israeli shareholders may be subject. The information below does not
      apply to specified persons or cover specified situations. Therefore, you are
      advised to consult your own tax advisor as to particular tax consequences unique
      to you related to an investment in our ordinary shares including the effects
      of
      applicable Israeli or foreign or other tax laws and possible changes in the
      tax
      laws.





To
      the
      extent that the discussion is based on legislation yet to be judicially or
      administratively interpreted, we cannot assure you that the views we express
      herein will accord with any such interpretation in the future.




*Tax
      Consequences Regarding Disposition of Our Ordinary Shares*





In
      general, Israel imposes capital gains tax on the sale of capital assets,
      including shares of Israeli companies by both Israeli residents and non-Israeli
      resident shareholders, unless a specific exemption is available or unless a
      tax
      treaty between Israel and the shareholders’ country of residence provide
      otherwise. Shareholders that are not Israeli residents are generally exempt
      from
      Israeli capital gains tax on any gain derived from the sale of our ordinary
      shares, provided that (i) such shareholders did not acquire the shares
      prior to our initial public offering; and (ii) such gains did not derive
      from a permanent establishment of such shareholders in Israel. However,
      non-Israeli corporations will not be entitled to the foregoing exemption if
      an
      Israeli resident (a) has a controlling interest of 25% or more in such
      non-Israeli corporation; or (b) is the beneficiary of or is entitled to 25%
      or more of the revenues or profits of such non-Israeli corporation, whether
      directly or indirectly.





In
      certain instances where our non-Israeli shareholders may be liable to Israeli
      tax on the sale of our ordinary shares, the payment of the consideration may
      be
      subject to Israeli withholding tax.





In
      addition, in the case when the sale, exchange or disposition of our ordinary
      shares by shareholders who are U.S. residents (within the meaning of the
      U.S.-Israel Tax Treaty) holding the ordinary shares as a capital asset will
      be
      also exempt from Israeli capital gains tax under the U.S.-Israel Tax Treaty,
      unless, either (i) the shareholders hold, directly or indirectly, shares
      representing 10% or more of our voting shares during any part of the 12-month
      period preceding such sale, exchange or disposition; or (ii) the capital
      gains arising from such sale, exchange or disposition are attributable to a
      permanent establishment of the shareholders located in Israel. In such case,
      the
      shareholders would be subject to Israeli capital gain tax, to the extent
      applicable, as mentioned above. However, under the U.S.-Israel Tax Treaty,
      the
      U.S. resident would be permitted to claim a credit for such taxes against
      the U.S. federal income tax imposed on the sale, exchange or disposition,
      subject to the limitation in the U.S. law applicable to foreign tax
      credits. The U.S.-Israel Tax Treaty does not relate to U.S. state or local
      taxes.


83





*Taxes
      Applicable to Dividends*





Nonresidents
      of Israel are generally subject to Israeli income tax on the receipt of
      dividends paid on our ordinary shares at the rate of 20% or 15% for dividends
      or
      income generated by an approved enterprise, which tax will be withheld at
      source, unless a different rate is provided in a treaty between Israel and
      the
      shareholder’s country of residence.





However,
      the tax rate on dividends paid to a “substantial shareholder” (which is someone
      who alone, or together with another person, holds, directly or indirectly, at
      least 10% in one or all of any of the means of control in the corporation)
      is
      25%.





Under
      Israeli tax law, a distribution of dividends from income attributable to an
      Approved Enterprise will be subject to tax in Israel at the rate of 15%, which
      is withheld and paid by the company paying the dividend, if the dividend is
      distributed during the benefits period or within the following 12 years (but
      the
      12-year limitation does not apply to a Foreign Investors Company). Any
      distribution of dividends from income that is not attributable to an Approved
      Enterprise after January 1, 2006, will be subject to tax in Israel at the rate
      of 20%.





Under
      the
      U.S.-Israel Tax Treaty, the maximum rate of tax withheld in Israel on dividends
      paid to a holder of our ordinary shares who is a U.S. resident (within the
      meaning of the U.S.-Israel Tax Treaty) is 25%. However, dividends paid from
      income derived from our Approved Enterprise are subject to withholding at the
      rate of 15%, although we cannot assure you that we will designate the profits
      that are being distributed in a way that will reduce shareholders’ tax liability
      according to the U.S.-Israel Tax Treaty. Furthermore, the maximum rate of
      withholding tax on dividends, not generated by our Approved Enterprise, that
      are
      paid to a U.S. corporation holding 10% or more of our outstanding voting
      capital during the part of the tax year that precedes the date of the payment
      of
      the dividend and during the whole of its prior tax year, is 12.5%. This reduced
      rate will not apply if more than 25% of our gross income consists of interest
      or
      dividends, other than dividends or interest received from a subsidiary
      corporation 50% or more of the outstanding shares of the voting shares of which
      are owned by the company.





A
      nonresident of Israel who receives dividends with respect of which tax was
      fully
      paid, is generally exempt from the duty to file returns in Israel in respect
      of
      such income, provided such income was not derived from a business conducted
      in
      Israel by the taxpayer, and the taxpayer has no other taxable sources of income
      in Israel.





***United
      States Federal Income Tax Considerations***





Subject
      to the limitations described herein, this discussion summarizes certain U.S.
      federal income tax consequences of the purchase, ownership and disposition
      of
      our ordinary shares to a U.S. holder. A U.S. holder is a holder of our ordinary
      shares that is:




·
            an
                individual citizen or resident of the U.S. for U.S. federal income
                tax
                purposes;


·
            a
                corporation (or another entity taxable as a corporation for U.S.
                federal
                income tax purposes) created or organized under the laws of the United
                States or any political subdivision thereof or the District of
                Columbia;


84





·
            an
                estate, the income of which is subject to U.S. federal income tax
                regardless of its source; or


·
            a
                trust (i) if, in general, a U.S. court is able to exercise primary
                supervision over its administration and one or more U.S. persons
                have the
                authority to control all of its substantial decisions or (ii) that
                has in
                effect a valid election under applicable U.S. Treasury Regulations
                to be
                treated as a U.S. person.





If
      a
      partnership (or any other entity treated as a partnership for U.S. federal
      income tax purposes) holds our ordinary shares, the tax treatment of the
      partnership and a partner in such partnership will depend on the status of
      the
      partner and the activities of the partnership. Such a partner or partnership
      should consult its tax advisor as to its consequences.





Unless  otherwise
      specifically indicated, this discussion does not consider the U.S. federal
      income tax consequences to a person that is not a U.S. holder of our ordinary
      shares (a “Non-U.S. holder”) and considers only U.S. holders that will own the
      ordinary shares as capital assets (generally, for investment).





This
      discussion is based on current provisions of the Internal Revenue Code of 1986,
      as amended, referred to as the Code, current and proposed Treasury Regulations
      promulgated under the Code and administrative and judicial interpretations
      of
      the Code, all as currently in effect and all of which are subject to change,
      possibly with a retroactive effect. This discussion does not address all aspects
      of U.S. federal income taxation that may be relevant to any particular U.S.
      holder based on the U.S. holder’s individual circumstances. In particular, this
      discussion does not address the U.S. federal income tax consequences to U.S.
      holders who are broker-dealers or who own, directly, indirectly or
      constructively, 10% or more (by voting power) of our outstanding voting shares,
      U.S. holders holding the ordinary shares as part of a hedging, straddle or
      conversion transaction, U.S. holders whose functional currency is not the U.S.
      dollar, insurance companies, financial service companies, real estate investment
      trusts, regulated investment trusts, grantor trusts, certain former citizens
      and
      long-term residents of the United States, tax-exempt organizations, financial
      institutions, persons who acquired their ordinary shares upon the exercise
      of
      employee stock options or otherwise as compensation, and persons subject to
      the
      alternative minimum tax, who may be subject to special rules not discussed
      below. Additionally, the possible application of U.S. federal estate or gift
      taxes or any aspect of state, local or non-U.S.  tax
      laws
      to a U.S. holder is not discussed below.





**You
      are advised to consult your tax advisor with respect to the specific U.S.
      federal, state, local, and foreign income and other tax consequences to you
      of
      purchasing, owning, or disposing of our ordinary
      shares.**


85





*Taxation
      of Distributions on the Ordinary Shares*





We
      have
      never paid dividends, and currently do not intend to pay dividends in the
      future. If we make distributions in the future, the amount of the distribution
      with respect to the ordinary shares will equal the amount of cash and the fair
      market value of any property distributed and will also include the amount of
      any
      non-U.S. tax withheld, including Israeli taxes withheld as described above
      under
“Taxation – Israeli Taxation.” Subject to the discussion below under “Tax
      Consequences if We Are a Passive Foreign Investment Company,” a distribution
      paid by us with respect to our ordinary shares to a U.S. holder will be treated
      as dividend income to the extent that the distribution does not exceed our
      current and accumulated earnings and profits, as determined for U.S. federal
      income tax purposes.  Dividends
      that are received by U.S. holders that are individuals, estates or trusts will
      be taxed at a reduced rate of tax (currently a maximum rate of 15% for taxable
      years beginning on or before December 31, 2010), provided that such dividends
      meet the requirements of “qualified dividend income.” Dividends that fail to
      meet such requirements, and dividends received by corporate U.S. holders, are
      taxed at ordinary income rates. No dividend received by a U.S. holder will
      be a
      qualified dividend (1) if the U.S. holder held the ordinary share with
      respect to which the dividend was paid for less than 61 days during the 121-day
      period beginning on the date that is 60 days before the ex-dividend date with
      respect to such dividend, excluding for this purpose, under the rules of Code
      Section 246(c), any period during which the U.S. holder has an option to sell,
      is under a contractual obligation to sell, has made and not closed a short
      sale
      of, is the grantor of a deep-in-the-money or otherwise nonqualified option
      to
      buy, or has otherwise diminished its risk of loss by holding other positions
      with respect to, such ordinary share (or substantially identical securities)
      or
      (2) to the extent that the U.S. holder is under an obligation (pursuant to
      a short sale or otherwise) to make related payments with respect to positions
      in
      property substantially similar or related to the ordinary share with respect
      to
      which the dividend is paid. If we were to be a “passive foreign investment
      company” (as such term is defined in the Code) for any taxable year, dividends
      paid on our ordinary shares in such year or in the following taxable year would
      not be qualified dividends. In addition, a non-corporate U.S. holder will be
      able to take a qualified dividend into account in determining its deductible
      investment  interest
      (which is generally limited to its net investment income) only if it elects
      to
      do so; in such case the dividend will be taxed at ordinary income rates. U.S.
      holders are urged to consult their own tax advisors regarding the U.S. federal
      income tax rate that would be applicable to their receipt of any dividends
      paid
      with respect to any ordinary shares.





The
      amount of any distribution that exceeds the amount treated as a dividend will
      be
      treated first as a nontaxable return of capital, reducing the U.S. holder’s tax
      basis in its ordinary shares to the extent thereof, and then as capital gain
      from the deemed disposition of the ordinary shares. Corporate holders will
      not
      be allowed a deduction for dividends received in respect of the ordinary
      shares.





Dividends
      paid by us in NIS will be included in the income of U.S. holders at the dollar
      amount of the dividend (including any non-U.S. taxes withheld therefrom) based
      upon the spot rate of exchange in effect on the date the distribution is
      included in income. U.S. holders will have a tax basis in NIS for U.S. federal
      income tax purposes equal to that dollar value. Any subsequent gain or loss
      in
      respect of NIS arising from exchange rate fluctuations generally will be taxable
      as U.S. source ordinary income or loss.


86





Subject
      to the limitations set forth in the Code and the Treasury Regulations
      thereunder, U.S.  holders
      may elect to claim as a foreign tax credit against their U.S. federal income
      tax
      liability the non-U.S. income tax withheld from dividends received in respect
      of
      the ordinary shares. The limitations on claiming a foreign tax credit include,
      among others, computation rules under which foreign tax credits allowable with
      respect to specific classes of income cannot exceed the U.S. federal income
      taxes otherwise payable with respect to each such class of income. In this
      regard, dividends paid by us generally will be foreign source “passive income”
for U.S. foreign tax credit purposes. U.S. holders that do not elect to claim
      a
      foreign tax credit may instead claim a deduction for the non-U.S. income tax
      withheld if they itemize deductions. The rules relating to foreign tax credits
      are complex, and you should consult your tax advisor to determine whether and
      to
      what extent you would be entitled to this credit. A U.S. holder will be denied
      a
      foreign tax credit for non-U.S. income tax withheld from a dividend received
      on
      the ordinary shares (i) if the U.S. holder has not held the ordinary shares
      for
      at least 16 days of the 31-day period beginning on the date that is 15 days
      before the ex-dividend date with respect to such dividend or (ii) to the extent
      the U.S. holder is under an obligation to make related payments with respect
      to
      positions in substantially similar or related property. Any days during which
      a
      U.S. holder has substantially diminished its risk of loss on the ordinary shares
      are not counted toward meeting the required 16-day holding period.





*Taxation
      on Disposition of the Ordinary Shares*





Subject
      to the discussion below under “Tax Consequences if We are a Passive Foreign
      Investment Company,” upon the sale, exchange or other disposition of our
      ordinary shares, a U.S. holder will recognize capital gain or loss in an amount
      equal to the difference between the amount realized on the disposition and
      the
      U.S. holder’s tax basis in the ordinary shares. The gain or loss recognized on
      the disposition will be long-term capital gain or loss if the U.S. holder held
      the ordinary shares for more than one year at the time of the disposition.
      Long-term capital gains are subject to a maximum tax rate of 15% for taxable
      years beginning on or before December 31, 2010. Gain or loss recognized by
      a
      U.S. holder on a sale, exchange or other disposition of ordinary shares
      generally will be treated as U.S. source income or loss for U.S. foreign tax
      credit purposes.





A
      U.S.
      holder that uses the cash method of accounting calculates the dollar value
      of
      the proceeds received on the sale as of the date that the sale settles. However,
      a U.S. holder that uses the accrual method of accounting is required to
      calculate the value of the proceeds of the sale as of the trade date and may
      therefore realize foreign currency gain or loss. A U.S. holder may avoid
      realizing foreign currency gain or loss by electing to use the settlement date
      to determine the proceeds of sale for purposes of calculating the foreign
      currency gain or loss. In addition, a U.S. holder that receives foreign currency
      upon the disposition of ordinary shares and converts the foreign currency into
      dollars after the settlement date or trade date (whichever date the U.S. holder
      is required to use to calculate the value of the proceeds of sale) will have
      foreign exchange gain or loss based on any appreciation or depreciation in
      the
      value of the foreign  currency
      against the dollar, which generally will be U.S. source ordinary income or
      loss.


87





*Tax
      Consequences If We Are a Passive Foreign Investment Company*





We
      will
      be a passive foreign investment company, or PFIC, for a taxable year if either
      (1) 75% or more of our gross income in the taxable year is passive income or
      (2)
      50% or more of the value, determined on the basis of a quarterly average, of
      our
      assets in the taxable year produce, or are held for the production of, passive
      income. If we own (directly or indirectly) at least 25% by value of the stock
      of
      another  corporation,
      we will be treated for purposes of the foregoing tests as owning our
      proportionate share of the other corporation’s assets and as directly earning
      our proportionate share of the other corporation’s gross income. We believe that
      in 2007 we were not a PFIC and currently we expect that we will not be a PFIC
      in
      2008. However, PFIC status is determined as of the end of the taxable year
      and
      is dependent on a number of factors, including our income, assets and the value
      of our ordinary shares. Therefore, there can be no assurance that we will not
      become a PFIC for the current fiscal year ending December 31, 2008 or in any
      future year. We will notify U.S. holders in the event we conclude that we will
      be treated as a PFIC for any taxable year.





If
      we are
      a PFIC, a U.S. holder must determine under which of three alternative taxing
      regimes it wishes to be taxed:




•
            The
                “QEF” regime applies if the U.S. holder elects to treat us as a “qualified
                electing fund” (“QEF”) for the first taxable year in which the U.S. holder
                owns our ordinary shares or in which we are a PFIC, whichever is
                later,
                and if we comply with certain reporting requirements. Under current
                law, a
                QEF election cannot be made with respect to warrants or options to
                acquire
                our ordinary shares. If the QEF regime applies, then each year that
                we are
                a PFIC such U.S. holder will include in its gross income a proportionate
                share of our ordinary earnings (which is taxed as ordinary income)
                and net
                capital gain (which is taxed as long-term capital gain), subject
                to a
                separate election to defer payment of taxes, which deferral is subject
                to
                an interest charge. These amounts would be included in income by
                an
                electing U.S. holder for its taxable year in which our taxable year
                ends,
                whether or not such amounts are actually distributed to the U.S.
                holder. A
                U.S. holder’s basis in our ordinary shares for which a QEF election has
                been made would be increased to reflect the amount of any taxed but
                undistributed income. Generally, a QEF election allows an electing
                U.S.
                holder to treat any gain recognized on the disposition of his ordinary
                shares as capital gain.





Once
      made, the QEF election applies to all subsequent taxable years of the U.S.
      holder in which it holds our ordinary shares and for which we are a PFIC, and
      can be revoked only with the consent of the United States Internal Revenue
      Service (“IRS”). The QEF election is made by attaching a completed IRS Form
      8621, including the PFIC annual information statement, to a timely filed U.S.
      federal income tax return. Even if a QEF election is not made, a U.S. holder
      who
      is a shareholder in a PFIC must file a completed IRS Form 8621 every year.
      If we
      believe we are or will become a PFIC, we will determine whether we will comply
      with the reporting requirements that would enable holders to make a QEF
      election. If a QEF election is made after the first taxable year in which a
      U.S.
      holder holds our ordinary shares and we are a PFIC, then special rules would
      apply.


88





•
            A
                second regime, the “mark-to-market” regime, may be elected so long as our
                ordinary shares are “marketable stock” (e.g., “regularly traded” on the
                Nasdaq Global Market). Pursuant to this regime, an electing U.S.
                holder’s
                ordinary shares are marked-to-market each taxable year that we are
                a PFIC
                and the U.S. holder recognizes as ordinary income or loss an amount
                equal
                to the difference as of the close of the taxable year between the
                fair
                market value of our ordinary shares and the U.S. holder’s adjusted tax
                basis therein. Losses are allowed only to the extent of net mark-to-market
                gain previously included by the U.S. holder under the election for
                prior
                taxable years. An electing U.S. holder’s adjusted basis in our ordinary
                shares is increased by income recognized under the mark-to-market
                election
                and decreased by the deductions allowed under the election. Under
                the
                mark-to-market election, gain on the sale of our ordinary shares
                is
                treated as ordinary income, and loss on the sale of our ordinary
                shares,
                to the extent the amount of loss does not exceed the net mark-to-market
                gain previously included, is treated as ordinary loss. Under current
                law,
                a mark-to-market election cannot be made with respect to warrants
                or
                options to acquire our ordinary shares. The mark-to-market election
                applies to the taxable year for which the election is made and all
                subsequent tax years, unless the ordinary shares cease to be marketable
                stock or the IRS consents to the revocation of the election. If the
                mark-to-market election is made after the first taxable year in which
                a
                U.S. holder holds our ordinary shares and we are a PFIC, then special
                rules would apply.




•
            A
                U.S. holder making neither the QEF election nor the mark-to-market
                election is subject to the “excess distribution” regime. Under this
                regime, “excess distributions” are subject to special tax rules. An excess
                distribution is either (1) a distribution with respect to ordinary
                shares
                that is greater than 125% of the average distributions received by
                the
                U.S. holder from us over the shorter of either the preceding three
                years
                or such U.S. holder’s holding period for our ordinary shares or (2) 100%
                of the gain from the disposition of our ordinary shares (including
                gain
                deemed recognized if the ordinary shares are used as security for
                a
                loan).





Excess
      distributions must be allocated ratably to each day that a U.S. holder has
      held
      our ordinary shares. A U.S. holder must include amounts allocated to the current
      taxable year and to any period prior to the first day of the first taxable
      year
      for which we are a PFIC in its gross income as ordinary income for the current
      taxable year. All amounts allocated to other taxable years of the U.S. holder
      would be taxed at the highest tax rate for each such other year applicable
      to
      ordinary income and would be subject to an interest charge on the deferred
      tax
      liability for each such other year calculated as if such liability had been
      due
      with respect to each such other year. The portions of distributions that are
      not
      characterized as “excess distributions” are subject to tax in the current year
      under the normal tax rules of the Code.





A
      U.S.
      person who inherits shares in a foreign corporation that was a PFIC in the
      hands
      of the decedent is denied the otherwise available step-up in the tax basis
      of
      such shares to fair market value at the date of death.





**The
      PFIC rules described above are complex. U.S. holders are urged to consult their
      tax advisors regarding the application of the PFIC rules, including eligibility
      for and the manner and advisability of making, the QEF election or the
      mark-to-market election.**


89





*Non-U.S.
      holders of Ordinary Shares*





Except
      as
      provided below, a Non-U.S. holder of ordinary shares will not be subject to
      U.S.
      federal income or withholding tax on the receipt of dividends on, and the
      proceeds from the disposition of, an ordinary share, unless, in the case of
      U.S.
      federal income taxes, that item is effectively connected with the conduct by
      the
      Non-U.S. holder of a trade or business in the United States and, in the case
      of
      a resident of a country that has an income tax treaty with the United States,
      that item is attributable to a permanent establishment in the United States
      or,
      in the case of an individual, a fixed place of business in the United States.
      In
      addition, gain recognized by an individual Non-U.S. holder on the disposition
      of
      the ordinary shares will be subject to tax in the United States if the Non-U.S.
      holder is present in the United States for 183 days or more in the taxable
      year
      of the sale and other conditions are met.





*Information
      Reporting and Backup Withholding*





A
      U.S.
      holder generally is subject to information reporting and may be subject to
      backup withholding at a rate of up to 28% with respect to dividend payments
      on,
      and the proceeds from the disposition of, the ordinary shares. Backup
      withholding will not apply with respect to payments made to exempt recipients,
      including corporations, or if a U.S. holder provides a correct taxpayer
      identification number certifies that such holder is not subject to backup
      withholding or otherwise establishes an exemption. Backup withholding is not
      an
      additional tax and may be claimed as a credit against the U.S. federal income
      tax liability of a U.S. holder, or alternatively, the U.S. holder may be
      eligible for a refund of any excess amounts withheld under the backup
      withholding rules, in either case, provided that the required information is
      furnished to the IRS.





Non-U.S.
      holders will generally not be subject to information reporting or backup
      withholding with respect to the payment of dividends on, and the proceeds from
      the disposition of, ordinary shares provided that the Non-U.S. holder provides
      its taxpayer identification number, certifies to its foreign status, or
      otherwise establishes an exemption.




**F.**
            **Dividend
                and Paying Agents**





Not
      applicable.




**G.**
            **Statement
                by Experts**





Not
      applicable.


90




**H.**
            **Documents
                on Display**





BluePhoenix
      is subject
      to the reporting requirements of the Exchange Act of 1934, as amended, that
      are
      applicable to a foreign private issuer. In accordance with the Exchange Act,
      we
      file with the SEC reports, including annual reports on Form 20-F by June 30
      each
      year. In addition, we file interim financial information on Form 6-K on a
      quarterly basis. We also furnish to the SEC under cover of Form 6-K certain
      other material information required to be made public in Israel, filed with
      and
      made public by any stock exchange or distributed by us to our
      shareholders. You may
      inspect without charge and copy at prescribed rates such material at the public
      reference facilities maintained by the SEC, 100 F Street, N.E., Washington,
      D.C.
      20549. You may also obtain copies of such material from the SEC at prescribed
      rates by writing to the Public Reference Section of the SEC, 100 F Street,
      N.E.,
      Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further
      information on the public reference room.





The
      SEC
      maintains an Internet site at http://www.sec.gov that
      contains reports and other material that are filed through the SEC’s Electronic
      Data Gathering, Analysis and Retrieval (“EDGAR”) system. BluePhoenix began
      filing through the EDGAR system beginning on November 14, 2002.





BluePhoenix
      ordinary shares are quoted on the NASDAQ Global Market. You may inspect reports
      and other information concerning BluePhoenix at the offices of the National
      Association of Securities Dealers, Inc., 9513 Key West Avenue, Rockville,
      Maryland 20850. You may also find our reports filed with the ISA on the Magna
      site whose address is http://www.magna.isa.gov.il.





Our
      Internet address is http://www.bphx.com .
      A copy
      of each report submitted in accordance with applicable United States law is
      available for public review at our principal executive offices.




**I.**
            **Subsidiary
                Information**





Not
      applicable.




**ITEM
      11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
      RISK** ****




In
      light
      of the nature of our activities, we invest our cash and cash equivalents, in
      short-term time deposits. As of December 31, 2007, we invested substantially
      all
      of the cash we held in NIS, dollars, euro and DKK currency accounts.
      Fluctuations in foreign currency exchange rates, such as euro or NIS versus
      the
      dollar may have a negative impact on our operating results and financial
      condition. In November 2007, we repaid our loans to banks under our credit
      facility. As of December 31, 2007, we had no outstanding loans. However, the
      interest rates that we will pay on future loans may have a major impact on
      our
      financial expenses.




**ITEM
      12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES**




Not
      applicable.


91




**P
      A R T II**




**ITEM
      13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES**




Not
      applicable.




**ITEM
      14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF
      PROCEEDS**




Not
      applicable.




**ITEM
      15. CONTROLS AND PROCEDURES**




(a) *Disclosure
      Controls and Procedures.*  Our
      management, with the participation of its chief executive officer and chief
      financial officer, evaluated the effectiveness of our disclosure controls and
      procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities
      Exchange Act) as of December 31, 2007. Based on this evaluation, our chief
      executive officer and chief financial officer have concluded that, as of such
      date, our disclosure controls and procedures were (i) designed
      to ensure that material information relating to us, including our consolidated
      subsidiaries, is made known to our management, including our
      chief executive officer and chief financial officer ,
      by
      others within those entities, as appropriate to allow timely decisions regarding
      required disclosure, particularly during the period in which this report was
      being prepared and (ii) effective, in that they provide reasonable assurance
      that information required to be disclosed by us in the reports that we file
      or
      submit under the Exchange Act is recorded, processed, summarized and reported
      within the time periods specified in the SEC’s rules and forms.




(b) *Management’s
      Annual Report on Internal Control over Financial Reporting* .
      Our
      board of directors and audit committee are responsible for establishing and
      maintaining adequate internal control over financial reporting. Our internal
      control system was designed to provide reasonable assurance regarding the
      reliability of financial reporting and the preparation and fair presentation
      of
      our consolidated financial statements.




Our
      chief
      executive officer and chief financial officer assessed the effectiveness of
      our
      internal control over financial reporting as of December 31, 2007. In making
      this assessment, they used the criteria established in Internal Control –
Integrated Framework issued by the Committee of Sponsoring Organizations of
      the
      Treadway Commission (COSO). Based on this assessment, our chief executive
      officer and chief financial officer have concluded that, as of December 31,
      2007, our internal control over financial reporting is effective based on those
      criteria.




92




Notwithstanding
      the foregoing, all internal control systems no matter how well designed have
      inherent limitations. Therefore, even those systems determined to be effective
      may not prevent or detect misstatements and can provide only reasonable
      assurance with respect to financial statement preparation and presentation.
      Also, projections of any evaluation of effectiveness to future periods are
      subject to the risk that controls may become inadequate because of changes
      in
      conditions, or that the degree of compliance with the policies or procedures
      may
      deteriorate.




(c) *Attestation
      Report of the Registered Public Accounting Firm* .
      This
      annual report includes an attestation report of our registered public accounting
      assessing our internal control over financial reporting.




(d) *Changes
      in Internal Control over Financial Reporting.* During
      the period covered by this report, there were no changes in our internal control
      over financial reporting that have materially affected, or are reasonably likely
      to materially affect, our internal control over financial reporting.




**ITEM
      16A. AUDIT COMMITTEE FINANCIAL EXPERT**




Our
      board
      of directors has determined that Mr. Michael Chill and Ms. Amira Berkovitz-Amir,
      both members of our audit committee, are "audit committee financial experts"
      and
      are independent as defined by applicable SEC regulations.




**ITEM
      16B. CODE OF ETHICS**




BluePhoenix
      has adopted a code of business conduct and ethics applicable to its executive
      officers, directors and all other employees. A copy of the code is available
      without charge to all BluePhoenix’s employees, investors and others upon request
      to the following address: BluePhoenix Solutions Ltd. 8 Maskit St. Herzliya
      46733, Israel, Attn: General Counsel. Any waiver of this code for executive
      officers or directors will be disclosed through the filing of a Form
      6-K.




**ITEM
      16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES** ****




***Policy
      of Pre-approval of Audit and Non-Audit Services of Independent
      Auditors***





Our
      audit
      committee is responsible for the oversight of our independent auditor’s work.
      The audit committee’s policy is to pre-approve all audit and non-audit services
      provided by Ziv Haft independent registered public accounting BDO member firm.
      These services may include audit services, audit-related services, tax services
      and other services, as further described below. The audit committee sets forth
      the basis for its pre-approval in detail, listing the particular services or
      categories of services that are pre-approved, and setting forth a specific
      budget for such services. Additional services may be pre-approved by the audit
      committee on an individual basis. Once services have been pre-approved, Ziv
      Haft
      independent registered public accountant BDO member firm and our management
      then
      report to the audit committee on a periodic basis regarding the extent of
      services actually provided in accordance with the applicable pre-approval,
      and
      regarding the fees for the services performed. ****





93




***Principal
      Accountant Fees and Services***





BluePhoenix
      paid the following fees for professional services rendered by Ziv Haft
      independent registered certified public accountants (Isr.) and other BDO member
      firm, for the years ended December 31, 2006 and 2007:





**2007**
            
            **2006**($
                in thousands)Audit
                Fees
            
            $
            371
            
            $
            302Audit-Related
                Fees
            
            $
            22
            
            
            -Tax
                Fees
            
            $
            98
            
            
            46All
                Other Fees
            
            
            -
            
            
            13**Total**
            
            $
            491
            
            $
            361





The
      audit
      fees for professional services rendered for the audits of our annual
      consolidated financial statements (including audit of our internal control
      over
      financial reporting in 2007), review of quarterly reports, statutory audits
      of
      BluePhoenix and its subsidiaries, issuance of comfort letters, consents and
      assistance with review of documents filed with the SEC.





Audit-related
      fees are fees for assurance and related services by the independent auditor
      that
      are reasonably related to the performance of the audit or review of our
      financial statements that are not disclosed under “Audit Fees.”





Tax
      fees
      were for services related to tax compliance, including the preparation of tax
      returns and claims for refund, and tax planning and tax advice, including
      assistance with tax audits and appeals, tax services for employee benefit plans
      and assistance with respect to requests for rulings from tax
      authorities.





Other
      fees for the year ended December 31, 2006 were for due diligence related to
      the
      acquisition of certain business activities of CodeStream.




**ITEM
      16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT
      COMMITTEES**




Not
      applicable.




**ITEM
      16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED
      PURCHASERS**





Not
      applicable.




94




**P
      A R T III**




**ITEM
      17. FINANCIAL STATEMENTS**




We
      have
      responded to Item 18 in lieu of this item.




**ITEM
      18. FINANCIAL STATEMENTS**




The
      financial statements required by this item are found at the end of this annual
      report, beginning on page F-1.




**ITEM
      19.** **EXHIBITS** ****




**Exhibit No.****1.1**
            
            English
                translation of the Memorandum of Association as amended on July 23,
                2003(1)**1.2**
            
            Articles
                of Association as amended on December 27, 2005(2)**4.1**
            
            Agreement
                dated December 14, 2006 among the registrant, CodeStream Software
                Ltd. and
                certain shareholders of CodeStream Software Ltd.(3)**4.2**
            
            Amendment
                dated as of December 30, 2007 among the Registrant, CodeStream Software
                Ltd. and those individuals and entities listed on Exhibit A
                hereto***4.3**
            
            Form
                of Indemnification Letter dated December 27, 2005 between the Registrant
                and certain office holders(2)**4.4**
            
            Master
                Services Agreement between BluePhoenix Solutions Nordic AS and SDC
                Udvikling A/S dated October 1, 2002(2)**4.5**
            
            BluePhoenix
                2003 Employee Share Option Plan (previously known as the Crystal
                1996
                Employee Share Option Plan), as amended on January 28, 1997, December
                5,
                1999, December 18, 2000, December 26, 2000, August 6, 2003 and December
                30, 2004(4)**4.6**
            
            The
                  2007 Award Plan adopted by the Registrant on July 8, 2007(4)**4.7**
            
            Form
                of Ordinary Shares Purchase Warrant dated as of November 21,
                2007(5)**4.9**
            
            Registration
                Rights Agreement dated as of November 21, 2007, among the Registrant
                and
                the purchasers signatory thereto(5)




95




**Exhibit No.****4.10**
            
            Agreement
                and Plan of Merger dated as of August 16, 2007, among the Registrant,
                ASNA
                Transitory Sub, Inc., Amalgamated Software of North America, Inc.,
                a
                committee comprised of each of Stuart Simke, Anne Ferguson and Phil
                Holthouse and the shareholders of Amalgamated Software of North America,
                Inc.**4.11**
            
            Stock
                Purchase Agreement, dated May 8, 2007, among Steven Dmiszewicki,
                Leonid
                Erlikh, Contrado Partners, LLC, SeaBreeze Partners, LLC and the Registrant***4.12**
            
            Software
                agreement between EDS and BluePhoenix Solutions UK Limited, dated
                October
                6, 2006***8.1**
            
            List
                of Subsidiaries***12.1**
            
            Certification
                of the Chief Executive Officer pursuant to §302 of the Sarbanes-Oxley
                Act***12.2**
            
            Certification
                of the Chief Financial Officer pursuant to§302
                of the Sarbanes-Oxley Act***13.1**
            
            Certification
                of the Chief Executive Officer pursuant to 18 U.S.C. §1350, as adopted
                pursuant to §906 of the Sarbanes-Oxley Act***13.2**
            
            Certification
                of the Chief Financial Officer pursuant to 18 U.S.C.§1350,
                as adopted pursuant to§906
                of the Sarbanes-Oxley Act***15**
            
            Consent
                of Ziv Haft registered certified public accountants (Isr.) BDO member
                firm*


**_______** **_____** __________


*  Filed
      herewith.




(1) Incorporated
      by reference to the Registrant’s Registration Statement on Form F-1 filed with
      the Securities and Exchange Commission on December 24, 1996.




(2) Incorporated by reference to the Registrant’s Annual Report on Form 20-F filed
      with the Securities and Exchange Commission on March 27, 2006.




(3) Incorporated by reference to the Registrant’s Annual Report on Form 20-F filed
      with the Securities and Exchange Commission on March 30, 2007, as amended on
      Form 20-F/A filed with the Securities and Exchange Commission on December 26,
      2007.




(4) Incorporated by reference to the Registrant’s Registration Statement on Form S-8
      filed with the Securities and Exchange Commission on October 31,
      2007.




(5) Incorporated by reference to the Registrant’s Registration Report on Form F-3
      filed with the Securities and Exchange Commission on January 7,
      2008.




96





SIGNATURES





The
      registrant hereby certifies that it meets all of the requirements for filing
      on
      Form 20-F and that it has duly caused and authorized the undersigned to sign
      this annual report on its behalf.





BLUEPHOENIX
                SOLUTIONS LTD.(Registrant)By:
            /s/
              Varda SagivVarda
                Sagiv
              Chief
                Financial Officer




Date:
      March 28, 2008







**EXHIBIT
      INDEX**





**Exhibit
                No.****1.1**
            
            English
                translation of the Memorandum of Association as amended on July 23,
                2003(1)**1.2**
            
            Articles
                of Association as amended on December 27, 2005(2)**4.1**
            
            Agreement
                dated December 14, 2006 among the registrant, CodeStream Software
                Ltd. and
                certain shareholders of CodeStream Software Ltd.(3)**4.2**
            
            Amendment
                dated as of December 30, 2007 among the Registrant, CodeStream Software
                Ltd. and those individuals and entities listed on Exhibit A
                hereto***4.3**
            
            Form
                of Indemnification Letter dated December 27, 2005 between the Registrant
                and certain office holders(2)**4.4**
            
            Master
                Services Agreement between BluePhoenix Solutions Nordic AS and SDC
                Udvikling A/S dated October 1, 2002(2)**4.5**
            
            BluePhoenix
                2003 Employee Share Option Plan (previously known as the Crystal
                1996
                Employee Share Option Plan), as amended on January 28, 1997, December
                5,
                1999, December 18, 2000, December 26, 2000, August 6, 2003 and December
                30, 2004(4)**4.6**
            
            BluePhoenix
                2007 Award Plan, adopted on July 8, 2007***4.7**
            
            Form
                of Ordinary Shares Purchase Warrant dated as of November 21,
                2007(5)**4.8**
            
            Securities
                Purchase Agreement dated as of November 19, 2007, by and among the
                Registrant and the purchasers identified in Exhibit A attached to
                the
                Securities Purchase Agreement(5)**4.9**
            
            Registration
                Rights Agreement dated as of November 21, 2007, among the Registrant
                and
                the purchasers signatory thereto(5)**4.10**
            
            Agreement
                and Plan of Merger dated as of August 16, 2007, among the Registrant,
                ASNA
                Transitory Sub, Inc., Amalgamated Software of North America, Inc.,
                a
                committee comprised of each of Stuart Simke, Anne Ferguson and Phil
                Holthouse and the shareholders of Amalgamated Software of North America,
                Inc.***4.11**
            
            Stock
                Purchase Agreement, dated May 8, 2007, among Steven Dmiszewicki,
                Leonid
                Erlikh, Contrado Partners, LLC, SeaBreeze Partners, LLC and the Registrant***4.12**
            
            Software
                agreement between EDS and BluePhoenix Solutions UK Limited, dated
                October
                6, 2006*









**8.1**
            
            List
                of Subsidiaries***12.1**
            
            Certification
                of the Chief Executive Officer pursuant to §302 of the Sarbanes-Oxley
                Act***12.2**
            
            Certification
                of the Chief Financial Officer pursuant to§302
                of the Sarbanes-Oxley Act***13.1**
            
            Certification
                of the Chief Executive Officer pursuant to 18 U.S.C. §1350, as adopted
                pursuant to §906 of the Sarbanes-Oxley Act***13.2**
            
            Certification
                of the Chief Financial Officer pursuant to 18 U.S.C.§1350,
                as adopted pursuant to§906
                of the Sarbanes-Oxley Act***15**
            
            Consent
                of Ziv Haft registered certified public accountants (Isr.) BDO member
                firm*


**____________**__________


*  Filed
      herewith.




(1) Incorporated
      by reference to the Registrant’s Registration Statement on Form F-1 filed with
      the Securities and Exchange Commission on December 24, 1996.




(2) Incorporated by reference to the Registrant’s Annual Report on Form 20-F filed
      with the Securities and Exchange Commission on March 27, 2006.




(3) Incorporated by reference to the Registrant’s Annual Report on Form 20-F filed
      with the Securities and Exchange Commission on March 30, 2007, as amended on
      Form 20-F/A filed with the Securities and Exchange Commission on December 26,
      2007.




(4) Incorporated by reference to the Registrant’s Registration Statement on Form S-8
      filed with the Securities and Exchange Commission on October 31,
      2007.




(5) Incorporated by reference to the Registrant’s Registration Report on Form F-3
      filed with the Securities and Exchange Commission on January 7,
      2008.







**BLUEPHOENIX
      SOLUTIONS LTD.**


**2007
      Annual Report**









**BLUEPHOENIX
      SOLUTIONS LTD.**




**2007
      CONSOLIDATED FINANCIAL STATEMENTS**





**TABLE
      OF CONTENTS**





**Page****Report
                of Independent Registered Public Accounting Firm**
            
            
            F-1
                - F-3**Consolidated
                Financial Statements:**Balance
                Sheets
            
            
            F-4Statements
                of Operations
            
            
            F-5Statements
                of Changes in Shareholders’ Equity
            
            
            F-6Statements
                of Cash Flows
            
            
            F-7
                - F-8Notes
                to Consolidated Financial Statements
            
            
            F-9
                - F-53








**The
      amounts are stated in U.S. dollars ($).**


______________________


_____________


______









bhpx




**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**




**To
      the Shareholders and Board of Directors of**




**BLUEPHOENIX
      SOLUTIONS LTD.**




We
      have
      audited the accompanying consolidated balance sheets of BluePhoenix Solutions
      Ltd. (the “Company”) and its subsidiaries as of December 31, 2007 and 2006 and
      the related consolidated statements of operations, changes in shareholders’
equity and cash flows for each of the three years in the period ended December
      31, 2007. These financial statements are the responsibility of the Company’s
      management. Our responsibility is to express an opinion on these financial
      statements based on our audits.




We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. An audit also includes examining,
      on a test basis, evidence supporting the amounts and disclosures in the
      financial statements, assessing the accounting principles used and significant
      estimates made by management, as well as evaluating the overall financial
      statement presentation. We believe that our audits provide a reasonable basis
      for our opinion.




In
      our
      opinion, the consolidated financial statements referred to above present fairly,
      in all material respects, the consolidated financial position of the Company
      and
      its subsidiaries as of December 31, 2007 and 2006, and the related consolidated
      results of their operations and cash flows for each of the three years in the
      period ended December 31, 2007, in conformity with accounting principles
      generally accepted in the United States of America.




As
      discussed in Note 1K to the consolidated financial statements, the Company
      changed its method of accounting for share-based compensation effective
      January 1, 2006 to conform with FASB Statement of Financial Accounting
      Standards No. 123 (revised 2004), “Share-Based Payment”.




We
      also
      have audited, in accordance with the standards of the Public Company Accounting
      Oversight Board (United States), the Company's internal control over financial
      reporting as of December 31, 2007, based on criteria established in Internal
      Control-Integrated Framework issued by the Committee of Sponsoring Organizations
      of the Treadway Commission (COSO) and our report dated March 28, 2008 expressed
      an unqualified opinion thereon.







Tel
      Aviv,
      Israel


March
      28,
      2008


Ziv
      Haft


Certified
      Public Accountants (Isr.)


BDO
      Member Firm




F-1


bhpx




**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**




**To
      the Shareholders and Board of Directors of**




**BLUEPHOENIX
      SOLUTIONS LTD.**







We
      have
      audited BluePhoenix Solutions Ltd.‘s (the “Company”) internal control over
      financial reporting as of December 31, 2007, based on criteria established
      in
      Internal Control-Integrated Framework issued by the Committee of Sponsoring
      Organizations of the Treadway Commission (the “COSO criteria”). The Company's
      management is responsible for maintaining effective internal control over
      financial reporting and for its assessment of the effectiveness of internal
      control over financial reporting, included in the accompanying Item 15b
      "Management Report Over Financial Reporting". Our responsibility is to express
      an opinion on the Company’s internal control over financial reporting based on
      our audit.




We
      conducted our audit in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether effective
      internal control over financial reporting was maintained in all material
      respects. Our audit included obtaining an understanding of internal control
      over
      financial reporting, assessing the risk that a material weakness exists, and
      testing and evaluating the design and operating effectiveness of internal
      control based on the assessed risk. Our audit also included performing such
      other procedures as we considered necessary in the circumstances. We believe
      that our audit provides a reasonable basis for our opinion.




A
      company’s internal control over financial reporting is a process designed to
      provide reasonable assurance regarding the reliability of financial reporting
      and the preparation of financial statements for external purposes in accordance
      with generally accepted accounting principles. A company’s internal control over
      financial reporting includes those policies and procedures that (1) pertain
      to
      the maintenance of records that, in reasonable detail, accurately and fairly
      reflect the transactions and dispositions of the assets of the company; (2)
      provide reasonable assurance that transactions are recorded as necessary to
      permit preparation of financial statements in accordance with generally accepted
      accounting principles, and that receipts and expenditures of the company are
      being made only in accordance with authorizations of management and directors
      of
      the company; and (3) provide reasonable assurance regarding prevention or timely
      detection of unauthorized acquisition, use, or disposition of the company’s
      assets that could have a material effect on the financial
      statements.




F-2




bhpx




Because
      of its inherent limitations, internal control over financial reporting may
      not
      prevent or detect misstatements. Also, projections of any evaluation of
      effectiveness to future periods are subject to the risk that controls may become
      inadequate because of changes in conditions, or that the degree of compliance
      with the policies or procedures may deteriorate.




In
      our
      opinion, the Company maintained in all material respects, effective internal
      control over financial reporting as of December 31, 2007, based on the COSO
      criteria.




We
      also
      have audited, in accordance with the standards of the Public Company Accounting
      Oversight Board (United States), the consolidated balance sheets of the Company
      and subsidiaries as of December 31, 2006 and 2007, and the related consolidated
      statements of operations, changes in shareholders’ equity and cash flows for
      each of the three years in the period ended December 31, 2007 and our report
      dated March 28, 2008 expressed an unqualified opinion thereon.




Tel
      Aviv,
      Israel


March
      28,
      2008


Ziv
      Haft


Certified
      Public Accountants (Isr.)


BDO
      Member Firm




F-3





**BLUEPHOENIX
        SOLUTIONS LTD.**


**CONSOLIDATED
      BALANCE SHEETS**




**December
                31,****2007**
            
            **2006****(in
                thousands)****ASSETS****CURRENT
                ASSETS:**Cash
                and cash equivalents
            
            $
            25,962
            
            $
            11,627Marketable
                securities
            
            
            668
            
            
            1,053Trade
                accounts receivable (Note 13A1)
            
            
            24,216
            
            
            26,489Other
                current assets (Note 13A2)
            
            
            2,481
            
            
            3,096Total
                current assets
            
            
            53,327
            
            
            42,265**LONG
                TERM ASSETS:**Long-Term
                Trade Receivables
            
            
            512
            
            
            1,390Investment
                in affiliated company
            
            
            207
            
            
            -Property
                and equipment, net (note 3)
            
            
            2,534
            
            
            2,147Goodwill
                (note 4)
            
            
            53,705
            
            
            44,838Intangible
                assets and other, net (note 5)
            
            
            36,573
            
            
            36,826Total
                long term assets
            
            
            93,531
            
            
            85,201**Total
                assets**
            
            $
            146,858
            
            $
            127,466**LIABILITIES
                AND SHAREHOLDERS’ EQUITY****CURRENT
                LIABILITIES:**Short-term
                bank credit and others (Note 6)
            
            $
            -
            
            $
            609Convertible
                debentures
            
            
            67
            
            
            4,482Accounts
                payable and accruals:Trade
            
            
            4,272
            
            
            4,594Deferred
                revenue
            
            
            6,829
            
            
            7,790Other
                (Note 13A3)
            
            
            16,860
            
            
            6,929Total
                current liabilities
            
            
            28,028
            
            
            24,404**LONG-TERM
                LIABILITIES:**Convertible
                debentures (Note 11B3)
            
            
            -
            
            
            14,049Accrued
                severance pay, net (Note 7)
            
            
            1,802
            
            
            1,718Provision
                for losses in formerly-consolidated subsidiary (Note 8)
            
            
            -
            
            
            1,971Loans
                from banks and others (Note 9)
            
            
            135
            
            
            20,027Total
                long-term liabilities
            
            
            1,937
            
            
            37,765**Total
                liabilities**
            
            
            29,965
            
            
            62,169**MINORITY
                INTERESTS**
            
            
            5,185
            
            
            5,348**COMMITMENTS
                AND CONTINGENCIES (Note 10)****SHAREHOLDERS’
                EQUITY (Note 11):**Share
                capital - ordinary shares of NIS 0.01 par value (authorized: December
                31, 2007 and 2006 - 30,000,000 shares; issued: December 31, 2007
                -
                22,274,221 shares; December 31, 2006 - 15,945,952 shares)
            
            
            44
            
            
            31Additional
                paid-in capital
            
            
            118,575
            
            
            58,556Accumulated
                other comprehensive loss
            
            
            (1,359
            )
            
            (1,537
            )Retained
                earnings
            
            
            7,996
            
            
            16,447125,256
            
            
            73,497Cost
                of 1,647,594 Company shares held by subsidiaries
            
            
            (13,548
            )
            
            (13,548
            )Total
                shareholders’ equity
            
            
            111,708
            
            
            59,949**Total
                liabilities and shareholders’ equity**
            
            $
            146,858
            
            $
            127,466




**The
      accompanying notes are an integral part of the consolidated financial
      statements.**






F-4





**BLUEPHOENIX
      SOLUTIONS LTD.**




**CONSOLIDATED
      STATEMENTS OF OPERATIONS**





**Year
                ended December 31,****2007**
            
            **2006**
            
            **2005****(in
                thousands, except per share data)**Revenues
                (Note 13B1):Products
            
            $
            20,464
            
            $
            10,150
            
            $
            8,718Services
            
            
            67,934
            
            
            57,854
            
            
            50,229Total
                revenues
            
            
            88,398
            
            
            68,004
            
            
            58,947Cost
                of revenues:Products
            
            
            2,929
            
            
            1,882
            
            
            1,570Services
            
            
            35,732
            
            
            26,633
            
            
            23,809Total
                cost of revenues
            
            
            38,661
            
            
            28,515
            
            
            25,379Gross
                profit
            
            
            49,737
            
            
            39,489
            
            
            33,568Research
                and development costs, net
            
            
            14,109
            
            
            9,400
            
            
            8,006Selling,
                general, and administrative expenses
            
            
            32,820
            
            
            22,149
            
            
            21,611Goodwill
                impairment
            
            
            6,989
            
            
            -
            
            
            -Restructuring
                (Note 13B3)
            
            
            694
            
            
            -
            
            
            -Operating
                income (loss)
            
            
            (4,875
            )
            
            7,940
            
            
            3,951Financial
                expenses, net (Note 13B4)
            
            
            4,343
            
            
            3,515
            
            
            1,978Other
                income, net (Note 13B5)
            
            
            892
            
            
            282
            
            
            104Income
                (loss) before taxes on income
            
            
            (8,326
            )
            
            4,707
            
            
            2,077Taxes
                on income (benefit) (Note 12)
            
            
            68
            
            
            (282
            )
            
            149(8,394
            )
            
            4,989
            
            
            1,928Share
                in earnings of affiliated company
            
            
            35
            
            
            -
            
            
            -Minority
                interest in losses (earnings) of subsidiaries, net
            
            
            163
            
            
            (317
            )
            
            (139
            )Net
                income (loss)
            
            $
            (8,196
            )
            $
            4,672
            
            $
            1,789**Earnings
                (loss) per share (Note 13C):**Basic
            
            $
            (0.48
            )
            $
            0.34
            
            $
            0.13Diluted
            
            $
            (0.48
            )
            $
            0.33
            
            $
            0.13**Weighted
                average number of shares outstanding (Note 13C):**Basic
            
            
            17,145
            
            
            13,889
            
            
            13,557Diluted
            
            
            17,145
            
            
            14,371
            
            
            13,960




**The
      accompanying notes are an integral part of the consolidated financial
      statements.**




F-5


**BLUEPHOENIX
        SOLUTIONS LTD.**


**CONSOLIDATED
      STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY**


**Share
                  capital****Number
                  of shares**
              
              **Par
                  value**
              
              **Additional
                  paid-in capital**
              
              **Accumulated
                  other comprehensive loss**
              
              **Retained
                  earnings**
              
              **Cost
                  of**
                **Company
                  shares held by subsidiaries**
              
              **Total****(in
                  thousands, except shares)****Balance
                  at December 31, 2004**
              
              
              13,549,539
              
              $
              31
              
              $
              54,953
              
              $
              (1,631
              )
              $
              9,986
              
              $
              (14,708
              )
              $
              48,631**Changes
                  during 2005:**Net
                  income
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              1,789
              
              
              -
              
              
              1,789Currency
                  translation adjustments
              
              
              -
              
              
              -
              
              
              -
              
              
              94
              
              
              -
              
              
              -
              
              
              94Total
                  comprehensive income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              1,883Issuance
                  of options
              
              
              -
              
              
              -
              
              
              48
              
              
              -
              
              
              -
              
              
              -
              
              
              48Change
                  in fair value of a conversion feature upon modification
              
              
              -
              
              
              -
              
              
              325
              
              
              
              
              
              
              
              
              
              
              
              325Classification
                  of warrants to equity
              
              
              -
              
              
              -
              
              
              848
              
              
              -
              
              
              -
              
              
              -
              
              
              848Exercise
                  of employee stock options
              
              
              10,299
              
              
              *
              
              
              31
              
              
              -
              
              
              -
              
              
              -
              
              
              31**Balance
                  at December 31, 2005**
              
              
              13,559,838
              
              
              31
              
              
              56,205
              
              
              (1,537
              )
              
              11,775
              
              
              (14,708
              )
              
              51,766**Changes
                  during 2006:**Net
                  income
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              4,672
              
              
              -
              
              
              4,672Total
                  comprehensive income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              4,672Issuance
                  of options
              
              
              -
              
              
              -
              
              
              48
              
              
              -
              
              
              -
              
              
              -
              
              
              48Stock-based
                  compensation
              
              
              -
              
              
              -
              
              
              40
              
              
              -
              
              
              -
              
              
              -
              
              
              40Conversion
                  of convertible debentures
              
              
              257,133
              
              
              *
              
              
              1,164
              
              
              -
              
              
              -
              
              
              -
              
              
              1,164Sale
                  of shares held by a subsidiary
              
              
              136,000
              
              
              *
              
              
              42
              
              
              -
              
              
              -
              
              
              492
              
              
              534Issuance
                  of shares with respect of acquisition of activity
              
              
              138,591
              
              
              *
              
              
              (37
              )
              
              -
              
              
              -
              
              
              668
              
              
              631Classification
                  of warrants to equity
              
              
              -
              
              
              -
              
              
              364
              
              
              -
              
              
              -
              
              
              -
              
              
              364Exercise
                  of employee stock options
              
              
              206,796
              
              
              *
              
              
              730
              
              
              -
              
              
              -
              
              
              -
              
              
              730**Balance
                  at December 31, 2006**
              
              
              14,298,358
              
              
              31
              
              
              58,556
              
              
              (1,537
              )
              
              16,447
              
              
              (13,548
              )
              
              59,949**Changes
                  during 2007:**Net
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (8,196
              )
              
              -
              
              
              (8,196
              )Unrealized gain on
                  available-for-sale marketable securities
              
              
              -
              
              
              -
              
              
              -
              
              
              178
              
              
              -
              
              
              -
              
              
              178Total
                  comprehensive income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (8,018
              )Stock-based and
                  RSUs compensation
              
              
              -
              
              
              -
              
              
              1,025
              
              
              -
              
              
              -
              
              
              -
              
              
              1,025Compensation
                  by former shareholder
              
              
              -
              
              
              -
              
              
              1,769
              
              
              -
              
              
              -
              
              
              -
              
              
              1,769Conversion
                  of convertible debentures
              
              
              1,363,656
              
              
              2
              
              
              6,822
              
              
              -
              
              
              -
              
              
              -
              
              
              6,824Conversion
                  of convertible notes series A
              
              
              2,062,297
              
              
              5
              
              
              11,911
              
              
              -
              
              
              -
              
              
              -
              
              
              11,916Exercise
                  of warrants
              
              
              210,000
              
              
              *
              
              
              840
              
              
              -
              
              
              -
              
              
              -
              
              
              840Issuance
                  of shares with respect of minority interests acquisition
              
              
              100,719
              
              
              *
              
              
              515
              
              
              -
              
              
              -
              
              
              -
              
              
              515Issuance
                  of shares, net
              
              
              1,999,998
              
              
              5
              
              
              32,918
              
              
              -
              
              
              -
              
              
              -
              
              
              32,923Implementation
                  of FSP EITF 00-19-2
              
              
              -
              
              
              -
              
              
              706
              
              
              -
              
              
              (255
              )
              
              -
              
              
              451Tax
                  benefit related to exercise of stock options
              
              
              -
              
              
              -
              
              
              594
              
              
              -
              
              
              -
              
              
              -
              
              
              594Exercise
                  of employee stock options and RSUs
              
              
              591,599
              
              
              1
              
              
              2,919
              
              
              -
              
              
              -
              
              
              -
              
              
              2,920**Balance
                  at December 31, 2007**
              
              
              20,626,627
              
              $
              44
              
              $
              118,575
              
              $
              (1,359
              )
              $
              7,996
              
              $
              (13,548
              )
              $
              111,708


*****  **Less
      than $1 thousand.**




**The
      accompanying notes are an integral part of the consolidated financial
      statements.**




F-6


**BLUEPHOENIX
      SOLUTIONS LTD.**




**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


**Year
                  ended December 31,****2007**
              
              **2006**
              
              **2005****(in
                  thousands)****CASH
                  FLOWS FROM OPERATING ACTIVITIES:**Net
                  income (loss)
              
              $
              (8,196
              )
              $
              4,672
              
              $
              1,789Adjustments
                  to reconcile net income (loss) to net cash provided by operating
                  activities:Minority
                  interests in losses (earnings) of subsidiaries
              
              
              (163
              )
              
              317
              
              
              139Share
                  in earnings of affiliated companies, net dividend received
              
              
              (2
              )
              
              -
              
              
              -Depreciation
                  and amortization
              
              
              12,087
              
              
              8,481
              
              
              7,001Goodwill
                  impairment
              
              
              6,989
              
              
              -
              
              
              -Increase
                  (decrease) in accrued severance pay, net
              
              
              (101
              )
              
              409
              
              
              (343
              )Loss
                  (gain) on sale of property and equipment
              
              
              4
              
              
              (32
              )
              
              (35
              )Change
                  in value of long term-loans and liabilities
              
              
              2,311
              
              
              1,853
              
              
              410Stock
                  - based and non cash compensations
              
              
              2,794
              
              
              40
              
              
              -Decreased
                  in provision for losses in formerly consolidated
                  subsidiary
              
              
              (300
              )
              
              -
              
              
              -Deferred
                  income taxes, net
              
              
              (1,025
              )
              
              13
              
              
              58Tax
                  benefit related to exercise of stock options
              
              
              594
              
              
              -
              
              
              -Changes
                  in operating assets and liabilities:Decrease
                  (increase) in marketable securities
              
              
              560
              
              
              (715
              )
              
              177Decrease
                  (increase) in trade receivables
              
              
              4,469
              
              
              (9,731
              )
              
              (1,221
              )Decrease
                  (increase) in other current assets
              
              
              975
              
              
              (909
              )
              
              544Increase
                  (decrease) in trade payables
              
              
              (679
              )
              
              1,390
              
              
              (1,939
              )Increase
                  (decrease) in other accounts payable
              
              
              (2,973
              )
              
              4,186
              
              
              (1,388
              )Net
                  cash provided by operating activities
              
              
              17,344
              
              
              9,974
              
              
              5,192**CASH
                  FLOWS FROM INVESTING ACTIVITIES:**Purchase
                  of property and equipment
              
              
              (1,086
              )
              
              (676
              )
              
              (700
              )Proceeds
                  from sale of property and equipment
              
              
              8
              
              
              161
              
              
              277Investment
                  and loans to affiliated and other companies
              
              
              -
              
              
              -
              
              
              (370
              )Capitalization
                  of research and development costs
              
              
              (5,302
              )
              
              (8,259
              )
              
              (8,117
              )Additional
                  consideration of previously acquired subsidiaries and
                  activities
              
              
              (1,310
              )
              
              (1,118
              )
              
              (180
              )Investment
                  in newly-consolidated subsidiaries and purchase of newly-activity
                  (Appendix A)
              
              
              (9,077
              )
              
              (13,224
              )
              
              (1,343
              )Net
                  cash used in investing activities
              
              
              (16,767
              )
              
              (23,116
              )
              
              (10,433
              )**CASH
                  FLOWS FROM FINANCING ACTIVITIES:**Short-term
                  bank credit, net
              
              
              (936
              )
              
              (14,013
              )
              
              153Repayment
                  of long-term loans
              
              
              (20,609
              )
              
              (1,149
              )
              
              (542
              )Receipt
                  of long-term loans
              
              
              -
              
              
              14,391
              
              
              7,003Issuance
                  of convertible debentures and warrants
              
              
              -
              
              
              14,140
              
              
              -Debentures
                  issuance costs
              
              
              -
              
              
              (655
              )
              
              -Repayment
                  of provision for losses in formerly consolidated
                  subsidiary
              
              
              (1,671
              )
              
              -
              
              
              -Issuance
                  of shares, net
              
              
              33,213
              
              
              -
              
              
              -Exercise
                  of employee share options and warrants
              
              
              3,761
              
              
              730
              
              
              31Sale
                  of shares held by a subsidiary
              
              
              -
              
              
              534
              
              
              -Net
                  cash provided by financing activities
              
              
              13,758
              
              
              13,978
              
              
              6,645**EFFECT
                  OF FOREIGN EXCHANGE RATE CHANGES ON CASH**
              
              
              
              
              
              -
              
              
              24NET
                  INCREASE IN CASH AND CASH EQUIVALENTS
              
              
              14,335
              
              
              836
              
              
              1,428CASH
                  AND CASH EQUIVALENTS AT BEGINNING OF YEAR
              
              
              11,627
              
              
              10,791
              
              
              9,363CASH
                  AND CASH EQUIVALENTS AT END OF YEAR
              
              $
              25,962
              
              $
              11,627
              
              $
              10,791




**The
      accompanying notes are an integral part of the consolidated financial
      statements.**






F-7


**BLUEPHOENIX
        SOLUTIONS LTD.**
  **CONSOLIDATED
        STATEMENTS OF CASH FLOWS**


**Year
                ended December 31,****2007**
            
            **2006**
            
            **2005****(in
                thousands)****SUPPLEMENTAL
                DISCLOSURE OF CASH FLOW INFORMATION:**Cash
                paid during the year for:Income
                taxes
            
            $
            995
            
            $
            239
            
            $
            1,221Interest
            
            $
            2,142
            
            $
            1,473
            
            $
            864




**APPENDIX
      A - INVESTMENT IN NEWLY-CONSOLIDATED SUBSIDIARIES AND PURCHASE OF
      ACTIVITY:**




**Year
                ended December 31,****2007**
            
            **2006**
            
            **2005****(in
                thousands)**Working
                capital, other than cash
            
            $
            2,785
            
            $
            1,486
            
            $
            105Investment
                and loans to affiliated Company
            
            
            (205
            )
            
            370
            
            
            -Property
                and equipment
            
            
            (303
            )
            
            (289
            )
            
            (100
            )Other
                intangible assets
            
            
            (1,317
            )
            
            -
            
            
            (564
            )Goodwill
            
            
            (5,975
            )
            
            (5,778
            )
            
            -Technology
            
            
            (2,423
            )
            
            (8,077
            )
            
            (1,158
            )Customer
                relations intangible asset
            
            
            (1,824
            )
            
            (470
            )
            
            -Non-current
                liabilities
            
            
            185
            
            
            (466
            )
            
            374Net
                cash used in acquisition
            
            $
            (9,077
            )
            $
            (13,224
            )
            $
            (1,343
            )




**APPENDIX
      B - NON-CASH ACTIVITIES:**




**Year
                ended December 31,****2007**
            
            **2006**
            
            **2005****(in
                thousands)**Investment
                in subsidiaries
            
            $
            246
            
            $
            275
            
            $
            1,577Purchase
                of minority interest in subsidiaries
            
            
            -
            
            
            -
            
            $
            100Conversion
                of convertible debentures
            
            $
            18,740
            
            $
            1,164
            
            
            -Unrealized
                gain on available-for-sale marketable securities
            
            $
            178
            
            
            -
            
            
            -Issuance
                costs
            
            $
            290
            
            
            -
            
            
            -




**The
      accompanying notes are an integral part of the consolidated financial
      statements.**




F-8




**BLUEPHOENIX
        SOLUTIONS LTD.**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**




**Note
      1 - Summary of Significant Accounting Policies:**




**A.**
            **General:**




The
      significant accounting policies, applied on a consistent basis, are as
      follows:




1.
            The
                Company:




BluePhoenix
      Solutions Ltd. (“BluePhoenix”) (together with its subsidiaries, the “Company”)
      is an Israeli corporation, which operates two operating segments that are
      aggregated to one reportable segment which is IT modernization solutions.




The
      Company develops and markets software tools and provides consulting services
      for
      efficient modernization of legacy systems and cross-platform migration. The
      Company manages its business in various international markets through several
      entities, including its wholly-owned subsidiaries located in: USA, UK, Denmark,
      Germany, Italy, Netherlands, Cyprus, Romania, and Israel. Listed below are
      details relating to BluePhoenix’s major subsidiaries:





**Shareholding
                percentage**
            
            **State
                of incorporation****Name**
            
            **2007**
            
            **2006****%****Subsidiaries:**BluePhoenix
                Solutions B.V. *
            
            
            100
            
            
            100
            
            
            NetherlandsBluePhoenix
                Solutions Nordic Aps *
            
            
            100
            
            
            100
            
            
            DenmarkBluePhoenix
                Solutions UK Ltd.
            
            
            100
            
            
            100
            
            
            United KingdomAdvanced
                Systems Europe B.V. *
            
            
            100
            
            
            100
            
            
            NetherlandsLiraz
                Systems Ltd. (“Liraz”)
            
            
            100
            
            
            100
            
            
            IsraelMainsoft
                Corporation (“Mainsoft”)
            
            
            58
            
            
            58
            
            
            USAAmalgamated
                Software North America (ASNA)
            
            
            100
            
            
            -
            
            
            USABridgeQuest
                Inc.
            
            
            100
            
            
            -
            
            
            USAOutlook
                & BluePhoenix Ltd.
            
            
            100
            
            
            100
            
            
            IsraelLiacom
                Ltd.
            
            
            51
            
            
            51
            
            
            IsraelI-Ter/Informatica
                & Territorio S.p.A.
            
            
            100
            
            
            100
            
            
            Italy


__________________________


*
      Indirectly through Liraz




2.
            Principal
                Shareholder:




Formula
      Systems (1985) Ltd. (“Formula”) held 56% of the Company’s shares as of December
      31, 2006. On June 19, 2007 Formula sold its entire shareholdings in BluePhoenix.




3.
            Accounting
                Principles:




The
      consolidated financial statements are prepared in accordance with accounting  principles
      generally accepted (“GAAP”) in the United States of America.




F-9




**BLUEPHOENIX
          SOLUTIONS LTD.**
  **NOTES
          TO CONSOLIDATED FINANCIAL STATEMENTS**




**Note
      1 - Summary of Significant Accounting Policies (Cont.):**




**A.**
            **General
                (cont.):**


4.
            Functional
                Currency:




The
      currency of the primary economic environment in which the operations of the
      Company and most of its subsidiaries are conducted is the U.S. dollar
      (“dollar”). In addition, a substantial portion of the Company’s revenues and
      costs are incurred in dollars. Thus, the functional and reporting currency
      of
      the Company is considered to be the dollar.




The
      Company follows SFAS 52 “Foreign Currency Translation” and accordingly non
      monetary transactions denominated in currencies other than the dollar are
      measured and recorded in dollar at the exchange rates prevailing at transaction
      date. Monetary assets and liabilities denominated in currencies other than
      the
      dollar are translated at the exchange rate on the balance sheet date. Exchange
      gain or losses on foreign currency translation are recorded in
      income.





5.
            Use
                of Estimates and Assumptions in the Preparation of the Financial
                Statements:




The
      preparation of financial statements in conformity with generally accepted
      accounting principles requires management to make estimates and assumptions
      that
      affect the reported amounts of assets and liabilities, disclosure of contingent
      assets and liabilities at the dates of the financial statements and the reported
      amounts of revenues and expenses during the reporting periods. Actual results
      could differ from those estimates.





**B.**
            **Principles
                of Consolidation:**




The
      consolidated financial statements include the accounts of BluePhoenix and its
      subsidiaries in which it has a controlling interest. Acquisition of subsidiaries
      is accounted for under the purchase method. All intercompany balances and
      transactions have been eliminated upon consolidation.





**C.**
            **Cash
                and Cash Equivalents:**




Cash
      equivalents are considered by the Company to be highly-liquid investments,
      including inter-alia, short-term deposits with banks, the majority of which
      did
      not exceed three months at the time of deposit and which are not
      restricted.




F-10




**BLUEPHOENIX
        SOLUTIONS LTD.**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**


**Note
      1 - Summary of Significant Accounting Policies (Cont.):**




**D.**
            **Provision
                for Doubtful Accounts:**




The
      provision for doubtful accounts was based on specific receivables, which their
      collection, in the opinion of Company’s management, is in doubt. Trade
      receivables are charged off in the period in which they are deemed to be
      uncollectible.





**E.**
            **Investee
                companies:**




Investments
      in affiliates over which the Company exercises significant influence but are
      not
      subsidiaries (affiliated companies) are accounted for under the equity
      method.





**F.**
            **Investments
                in Marketable Securities:**




The
      Company accounts for investments in marketable securities in accordance with
      SFAS No. 115 "Accounting for Certain Investments in Debt and Equity
      Securities".


Management
      determines the appropriate classification of its investments at the time of
      purchase and reevaluates such determinations at each balance sheet
      date.


All
      marketable securities are reported at fair value. Unrealized gains or losses
      from securities which are classified as trading are charged to income. Available
      for sale securities are carried at fair value, with the unrealized gains and
      losses, reported in "accumulated other comprehensive income (loss)" in
      shareholders' equity.





**G.**
            **Property
                and Equipment, Net:**




Property
      and equipment are stated at cost, net of accumulated depreciation. Depreciation
      is calculated by the straight-line method over their estimated useful lives.
      Annual rates of depreciation are as follows:




**%**Computers
                and peripheral equipment
            20-33
                (mainly 33)Office
                furniture and equipment
            6-15
                (mainly 7)Leasehold
                improvements
            Over
                the shorter of lease term or the life of the assetsMotor
                vehicles
            15




F-11




**BLUEPHOENIX
        SOLUTIONS LTD.**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**


**Note
      1 - Summary of Significant Accounting Policies (Cont.):**




**H.**
            **Impairment
                of Long-Lived Assets:**




The
      Company’s long-lived assets are reviewed for impairment in accordance with SFAS
      No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets”
whenever events or changes in circumstances indicate that the carrying amount
      of
      an asset may not be recoverable. Recoverability of assets to be held and used
      is
      measured by a comparison of the carrying amount of an asset to the future
      undiscounted cash flows expected to be generated by the assets. If such assets
      are considered to be impaired, the impairment to be recognized is measured
      by
      the amount by which the carrying amount of the assets exceeds their fair value.
      During the years ended December 31, 2007, 2006 and 2005, no impairment losses
      have been identified.





**I.**
            **Goodwill
                and other purchased intangible assets**:




Goodwill
      and certain other purchased intangible assets have been recorded as a result
      of
      acquisitions. Goodwill represents the excess of the purchase price in a business
      combination over the fair value of net tangible and intangible assets
      acquired.




Goodwill
      is not amortized, but rather is subject to an annual impairment test. The
      Company performs an annually impairment test, or more frequently if impairment
      indicators are present. Intangible assets that are not considered to have an
      indefinite useful life are amortized using the straight-line basis over their
      estimated useful lives. The carrying amount of these assets is reviewed whenever
      events or changes in circumstances indicate that the carrying value of an asset
      may not be recoverable. Recoverability of these assets is measured by comparison
      of the carrying amount of the asset to the future undiscounted cash flows the
      assets is expected to generate. If the asset is considered to be impaired,
      the
      amount of any impairment is measured as the difference between the carrying
      value and the fair value (usually discounted cash flow) of the impaired
      asset.




During
      the fourth quarter of 2007 the Company performed an impairment test to its
      goodwill attributed to Mainsoft Inc. (hereinafter: "Mainsoft"). Mainsoft is
      considered to be a reporting unit pursuant to SFAS 142 "Goodwill and Other
      Intangible Assets". The goodwill impairment test conducted in two steps as
      set
      forth in paragraphs 19-20 to SFAS 142. After analyzing the second step the
      Company determined that the carrying amount of the reporting unit goodwill
      exceeds its implied fair value.




The
      Company calculated an impairment loss of $7 million which was charged to
      operating expenses.




There
      can
      be no assurance that future goodwill impairment tests will not result in
      additional charges to earnings.




F-12




**BLUEPHOENIX
        SOLUTIONS LTD.**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**


**Note
      1 - Summary of Significant Accounting Policies (Cont.):**




**J.**
            **Research
                and Development Costs:**




Research
      and development costs of software and products enhancement that are intended
      for
      sale and acquired technology which were incurred after the establishment of
      technological feasibility of the relevant product, are capitalized.
      Technological feasibility is determined when detailed program design is
      completed and verified in accordance with the provisions of SFAS No. 86
“Accounting for the Cost of Computers Software to Be Sold, Leased or Otherwise
      Marketed.” Research and development costs before technological feasibility is
      established are charged to the statement of operations as incurred, net of
      participation of the Office of the Chief Scientist of the Israeli Ministry
      of
      Industry and Trade (the “OCS”).




Amortization
      of capitalized research development costs begins when the product is available
      for general release to customers. Annual amortization is computed by the
      straight-line method, over the remaining useful life of the product, or based
      on
      the ratio of current gross revenues to current and anticipated future gross
      revenues, whichever is higher. Currently, capitalized research and development
      costs are amortized over a period of 5 years. During the year ended December
      31,
      2007, the Company capitalized research and development costs aggregating $5.3
      million (in 2006: $8.3 million, and in 2005: $8.1 million) and amortized
      capitalized research and development costs aggregating $10.5 million (in 2006:
      $7.1 million, and in 2005: $5.1 million) included in cost of
      revenues.




In
      the
      Company's management estimate, total capitalized costs do not exceed the net
      realizable value of the software product. In the event that unamortized research
      and development costs exceed the net realizable value of the product, they
      would
      be written down to net realizable value.





**K.**
            **Employee
                Share Options:**




Effective
      January 1, 2006, the Company adopted the provisions of Statement of
      Financial Accounting Standard No. 123 (revised 2004) (“FAS 123R”),
“Share-Based Payment,” and Staff Accounting Bulletin No. 107 (“SAB 107”),
      which was issued in March 2005 by the SEC. FAS 123R addresses the accounting
      for
      share-based payment transactions in which the Company obtains employee services
      in exchange for equity instruments of the Company. This statement requires
      that
      employee equity awards be accounted for using the grant-date fair value method.
      SAB 107 provides supplemental implementation guidance on FAS 123R, including
      guidance on valuation methods, classification of compensation expense, income
      statement effects, disclosures and other issues.




F-13




**BLUEPHOENIX
        SOLUTIONS LTD.**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**


**Note
      1 - Summary of Significant Accounting Policies (Cont.):**




**K.**
            **Employee
                Share Options (cont.):**




FAS
      123R
      supersedes the Company’s previous accounting for its employee stock option plans
      using the intrinsic value-based method of accounting prescribed under Accounting
      Principles Board Opinion No. 25 (“APB 25”) and related
      interpretations. The Company elected to adopt the modified prospective
      transition method permitted by FAS 123R. Under such transition method, the
      new
      standard has been implemented as from January 1, 2006, with no restatement
      of prior periods to reflect the fair value method of expensing share-based
      compensation.




The
      Company has expensed compensation costs, applying the accelerated vesting
      method, (graded vesting) based on the grant-date fair value estimated in
      accordance with the original provisions of FAS 123, and previously presented
      in
      the pro forma footnote disclosures. Results for prior periods have not been
      restated as explained above. For the year ended December 31, 2007 and 2006,
      the Company recorded stock-based and RSUs compensation costs in the amount
      of
      $1,025 and $40 thousand, respectively. On December 31, 2007, the total
      unrecognized stock-based and RSUs compensation costs amounted to $1,701
      thousand, and are expected to be recognized over a weighted average period
      of 3
      years.




The
      Company issues stock options and restricted share units to its employees and
      directors and provides the right to purchase stock pursuant to approved stock
      option and employee stock purchase programs. Prior to the adoption of FAS 123R,
      the Company elected to follow Accounting Principles Board Opinion No. 25,
“Accounting for Stock Options Issued to Employees” and related interpretations
      (collectively “APB No. 25”), in accounting for its stock option plans. Under APB
      No. 25, when the exercise price of an employee stock option is less than the
      market price of the underlying stock on the date of grant, compensation expense
      is recognized. No stock-based employee compensation cost was recognized in
      income for the year ended December 31, 2005, as all options granted under those
      plans had an exercise price equal to the market value of the underlying common
      stock on the date of the grant. In 2007, the Company recorded tax benefit in
      the
      amount of $594 thousand as a result of exercised stock options.




F-14




**BLUEPHOENIX
        SOLUTIONS LTD.**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**


**Note
      1 - Summary of Significant Accounting Policies (Cont.):**




**K.**
            **Employee
                Share Options (cont.):**




The
      following table illustrates the effect on net income and earnings per share,
      assuming the Company had applied the fair value recognition provisions of FAS
      123 to its stock-based employee compensation in fiscal 2005:




**Year
                ended December 31, 2005****(in
                thousands,**
              **except**
              **per
                share data)**Net
                income as reported
            
            $
            1,789Deduct:
                Total stock-based employee compensation expense determined under
                fair
                value based method for all awards, net of related
                tax effects
            
            
            *(1,851
            )Pro
                forma net income
            
            $
            (62
            )Earnings
                per share:Basic
                - as reported
            
            $
            0.13Basic
                - pro forma
            
            $
            (0.00
            )Diluted
                - as reported
            
            $
            0.13Diluted
                - pro forma
            
            $
            (0.00
            )





*  Mainly
      due to an acceleration of unvested stock options. (see also Note
      11D(1)(b)).





**L.**
            **Revenue
                Recognition:**




Revenues
      derived from direct software license agreements are recognized in accordance
      with Statement of Position (SOP) 97-2 “Software Revenue Recognition” (as amended
      by SOP 98-4 and SOP 98-9), upon delivery of the software, when collection is
      probable, the license fee is otherwise fixed or determinable and persuasive
      evidence of an arrangement exists.




The
      arrangements that include multiple elements are usually arrangements where
      the
      Company sells software products and Post Contract Support (PCS).




For
      multiple elements arrangements, SOP 97-2 requires that the fair value of each
      component in a multiple element arrangement will be determined based on the
      vendor’s specific objective evidence (VSOE) for that element, and revenue is
      allocated to each component based on its fair value. SOP 98-9 requires that
      revenue be recognized under the “residual method” when VSOE does not exist for
      all the delivered elements, VSOE of fair value exists for all undelivered
      elements, and all other SOP 97-2 criteria are met. The specific objective
      evidence for the PCS is established by the price charged on PCS sold separately
      or renewed.




F-15




**BLUEPHOENIX
        SOLUTIONS LTD.**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**


**Note
      1 - Summary of Significant Accounting Policies (Cont.):**




**L.**
            **Revenue
                Recognition (cont.):**




The
      Company recognizes revenues from consulting fees based on the number of hours
      performed.


In
      some
      of the agreements with the Company’s customers, the customers have the right to
      receive unspecified upgrades on an if-and-when available basis (the Company
      does
      not provide specific upgrades). These upgrades are considered Post-Contract
      Support (PCS). Revenue allocated to the PCS is recognized ratably over the
      term
      of the PCS.





When
      a
      project involves significant production, modification, or customization of
      software, revenue is recognized according to the percentage of completion
      method, in accordance with the provisions of SOP 81-1 “Accounting for
      Performance of Construction-Type Contracts.” Under this method, estimated
      revenue is generally accrued based on costs incurred to date, as a percentage
      of
      total updated estimated costs.





The
      Company recognizes contract losses, if any, in the period in which they first
      become evident.




Some
      of
      the Company’s contracts include client acceptance clauses. In these contracts,
      the Company follows the guidance of TPA 5100.67 and SAB 104. In determining
      whether revenue can be recognized, when an acceptance clause exists, the Company
      considers its history with similar arrangements, the customer’s involvement in
      the progress, and the existence of other service providers and the payments
      terms. There are no rights of return, price protection or similar contingencies
      in the Company’s contracts.




On
      December 31, 2007 approximately $7.9 million (on December 31, 2006: $13.7
      million) of the accounts receivable balance was unbilled due to the customers
      payment terms.





The
      Company presents revenues from products and revenues from services in separate
      line items.


The
      product revenues line item includes revenues generated from (i) standalone
      software products and (ii) software products that were included in
      multiple-element arrangements and were separated pursuant to SOP 97-2 as
      aforementioned.





In
      the
      services revenue line item, the Company included (i) revenues generated from
      standalone consulting services, (ii) revenues generated from standalone post
      contract support ("PCS"), (iii) revenues accounted for pursuant to SOP 81-1
      and
      (iv) revenues generated from PCS included in multiple-element arrangement and
      were separated pursuant to SOP 97-2 as aforementioned.





Tax
      collected from customers and remitted to governments authorities (including
      VAT)
      are presented in income statement on a net basis.




F-16




**BLUEPHOENIX
        SOLUTIONS LTD.**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**




**Note
      1 - Summary of Significant Accounting Policies (Cont.):**




**M.**
            **Advertising
                Costs:**




The
      Company expenses advertising costs as incurred. Advertising costs for the years
      ended December 31, 2007, 2006, and 2005 were $161, $125, and $39 thousand,
      respectively.





**N.**
            **Income
                Taxes:**




Effective
      January 1, 2007, the Company adopted FIN 48, “Accounting for Uncertainty in
      Income Taxes - an interpretation of FAS 109”, which was issued in June 2006. FIN
      48 clarifies the accounting for uncertainty in income taxes, and prescribes
      a
      recognition threshold and measurement attributes for the financial statement
      recognition and measurement of a tax position taken or expected to be taken
      in a
      tax return. The Company’s accounting policy, pursuant to the adoption of FIN 48,
      is to classify interest and penalties recognized in the financial statements
      relating to uncertain tax positions under the provision for income taxes.


The
      adoption of FIN 48 did not result in a change to the Company's retained earning.
      As of December 31, 2007, there are no unrecognized tax benefits.





Deferred
      taxes are determined utilizing the “asset and liability” method, whereby
      deferred tax asset and liability account balances are determined based on
      differences between financial reporting and the tax bases of assets and
      liabilities and are measured using the enacted tax rates and laws that will
      be
      in effect when the differences are expected to reverse. The Company provides
      a
      valuation allowance, when it’s more likely than not that deferred tax assets
      will not be realized in the foreseeable future.





**O.**
            **Earnings
                (loss) Per Share:**




Earnings
      (loss) per share (“EPS”) were computed in accordance with the provisions of SFAS
      No. 128 of the FASB (“SFAS No. 128”). SFAS No. 128 requires the presentation of
      both basic and diluted EPS.


Basic
      net
      earnings per share are computed based on the weighted average number of ordinary
      shares outstanding during each year. Diluted earnings per share is computed
      based on the weighted average number of ordinary shares outstanding during
      each
      year, plus dilutive potential ordinary shares considered outstanding during
      the
      year.




F-17




**BLUEPHOENIX
        SOLUTIONS LTD.**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**


**Note
      1 - Summary of Significant Accounting Policies (Cont.):**




**P.**
            **Financial
                Instruments:**




1.
            Management
                of credit risks:




Financial
      instruments that have the potential to expose the Company to credit risks are
      mainly cash and cash equivalents, marketable securities, bank deposit accounts,
      and trade receivables.




The
      Company holds cash and cash equivalents, marketable securities, and deposit
      accounts at large banks in Israel, the United States, and Europe, thereby
      substantially reducing the risk of loss.




With
      respect to trade receivables, the risk is limited due to the nature and size
      of
      the entities that constitute the Company’s customer base. The Company assesses
      the financial position of its customers prior to the engagement with them,
      and
      has not encountered material credit difficulties therewith.





2.
            Fair
                value of financial instruments:




The
      financial instruments of the Company consist mainly of cash and cash
      equivalents, marketable securities, bank deposit accounts, credit facilities,
      trade payables, trade receivables and derivatives.




The
      carrying amount of cash and cash equivalents, trade receivables and trade
      payables approximates their fair values due to the short-term maturities of
      these instruments. The fair value of marketable securities is based on quoted
      market prices. The fair value of derivative instruments is estimated by using
      a
      fair value model.





**Q.**
            **Comprehensive
                Income:**




The
      Company accounts for comprehensive income in accordance with SFAS No. 130,
      "Reporting Comprehensive Income". This statement establishes standards for
      the
      reporting and display of comprehensive income and its components in a full
      set
      of general purpose financial statements. Comprehensive income generally
      represents all changes in stockholders' equity during the period except those
      resulting from investments by, or distributions to, stockholders. The Company
      determined that its items of other comprehensive income relates to gains and
      losses on available for sale securities and currency translation
      adjustment.




F-18





**BLUEPHOENIX
      SOLUTIONS LTD.**




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**Note
      1 - Summary of Significant Accounting Policies (Cont.):**




**R.**
            **Derivative
                Instruments:**




The
      Company has adopted Statement of Financial Accounting Standards SFAS No. 133
      “Accounting for Derivative Instruments and Hedging Activities.” Under the
      provisions of SFAS 133, all derivatives are recognized on the balance sheet
      at
      their fair value. Changes in fair value are recognized periodically in earnings
      or accumulated other comprehensive income within shareholders’ equity, depending
      on the intended use of the derivative and whether the derivative has been
      designated by management as a hedging instrument. Changes in fair value of
      derivative instruments not designated as hedging instruments are recognized
      in
      earnings in the current period.




The
      Company uses foreign currency options, forward exchange contracts and forward
      interest contracts to assist in managing financial risks. The Company does
      not
      use derivative financial instruments for speculative purposes. These instruments
      are recognized at fair value, with all changes in fair value recorded in current
      period earnings, as these transactions have not been designated by management
      as
      hedging instruments under SFAS 133. The net gain recognized in earnings during
      2007, representing the derivative instruments was $833 thousand (in 2006: $275
      thousands). As of December 31, 2007, the Company entered into LIBOR interest
      forward transaction for $8.4 million at an average interest rate of 4.95%.
      The
      Company has no open forward exchange rate contracts as of this
      date.





**S.**
            **Royalty-Bearing
                Grants:**




Royalty-bearing
      grants from the Government of Israel and other governmental institutions for
      funding approved research and development projects are recognized at the time
      the Company is entitled to such grants. Such grants are included as a deduction
      of research and development costs. Grants received in 2007, 2006 and 2005
      amounted to $420, $417 and $319 thousand, respectively. The Company is committed
      to pay royalties related to grants from the Government of Israel on sales with
      regard to the funded products of approximately 3% of the generated revenues
      from
      such products. These royalties are recognized as costs of revenues when it
      is
      probable that the Company will have to pay them. As of December 31, 2007, the
      liability in respect to these royalties amounted to $14 thousand.





**T.**
            **Treasury
                Shares:**




Treasury
      shares are presented as a reduction of shareholders' equity, at their cost
      to
      the Company.




F-19




**BLUEPHOENIX
      SOLUTIONS LTD.**




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**Note
      1 - Summary of Significant Accounting Policies (Cont.):**




**U.**
            **Transfers
                of Financial Assets**




SFAS
      No.
      140, Accounting for Transfers and Servicing of Financial Assets and
      Extinguishments of Liabilities (SFAS No. 140) **,** establishes
      a standard for determining when a transfer of financial assets should be
      accounted for as a sale. The underlying conditions are met for the transfer
      of
      financial assets to qualify for accounting as a sale. The transfers of financial
      assets are typically performed by the sell of receivables to on a financial
      institution.




In
      2007,
      the Company sold trade receivables to financial institution in a total amount
      of
      $11.4 million at an average annual rate of Libor plus 1.75%. Control and risk
      of
      those trade receivables were fully transferred and accounted for as a sale
      in
      accordance with SFAS No. 140. The agreements, pursuant to which the Company
      sells its trade receivables, are structured such that the Company (i) transfers
      the proprietary rights in the receivable from the Company to the financial
      institution; (ii) legally isolates the receivable from the Company’s other
      assets, and presumptively puts the receivable beyond the legal reach of the
      Company and its creditors, even in bankruptcy or other receivership; (iii)
      confers on the financial institution the right to pledge or exchange the
      receivable; and (vi) eliminates the Company’s effective control over the
      receivable, in the sense that the Company is not entitled and shall not be
      obligated to repurchase the receivable other than in case of failure by the
      Company to fulfill its commercial obligation.





**V.**
            **Registration
                Payment Arrangements**




The
      Company accounts for registration payment arrangements pursuant to FSP, 00-19-2,
      “Accounting for Registration Payment Arrangements.” The FSP specifies that the
      contingent obligation to make future payments or otherwise transfer
      consideration under a registration payment arrangement, whether issued as a
      separate agreement or included as a provision of a financial instrument or
      other
      agreement should be separately recognized and measured in accordance with FAS
      No. 5, “Accounting for Contingencies.” The FSP further clarifies that a
      financial instrument subject to a registration payment arrangement should be
      accounted for in accordance with other applicable GAAP without regard to the
      contingent obligation to transfer consideration pursuant to the registration
      payment arrangement. The FSP was effective immediately for registration payment
      arrangements and financial instruments subject to those arrangements that were
      entered into or modified subsequent to December 15, 2006. For registration
      payment arrangements and financial instruments subject to those arrangements
      that were entered into prior to December 15, 2006, the FSP was effective
      for fiscal years beginning after December 15, 2006, and interim periods
      within those fiscal years. The Company adopted FSP 00-19-2 at the beginning
      of
      January 1, 2007. The adoption affected the beginning of the year equity
      (see note 11B3).




F-20




**BLUEPHOENIX
      SOLUTIONS LTD.**




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**Note
      1 - Summary of Significant Accounting Policies (Cont.):**




**W.**
            **Recently
                Issued Accounting
                Pronouncements:**




In
      September 2006, the Financial Accounting Standards Board ("FASB") issued SFAS
      No. 157, "Fair Value Measurements" ("SFAS No. 157"). This Standard defines
      fair
      value, establishes a framework for measuring fair value in generally accepted
      accounting principles and expands disclosures about fair value measurements.
      The
      provisions of SFAS No. 157 are effective for the Company beginning January
      1,
      2008. The FASB issues a FASB Staff Position (FSP) to defer the effective date
      of
      SFAS No. 157 for one year for all nonfinancial assets and nonfinancial
      liabilities, except for those items that are recognized or disclosed at fair
      value in the financial statements on a recurring basis. The Company does not
      expect the adoption will have material impact on its consolidated financial
      statements.




In
      February 2007, the FASB issued FAS 159, “The Fair Value Option for Financial
      Assets and Financial Liabilities.” This standard permits entities to choose to
      measure many financial assets and financial liabilities at fair value.
      Unrealized gains and losses on items for which the fair value option has been
      elected are reported in earnings. As applicable to the Company, this statement
      will be effective as of the year beginning January 1, 2008. The Company
      does not expect the adoption of FAS 159 to have a material impact on its
      consolidated financial statements.





In
      December 2007, the FASB issued SFAS No. 141(R), “Business Combinations.” SFAS
      No. 141(R) establishes principles and requirements for how an acquirer
      recognizes and measures in its financial statements the identifiable assets
      acquired, the liabilities assumed, the goodwill acquired, and any noncontrolling
      interest in the acquire. This Statement also establishes disclosure requirements
      to enable the evaluation of the nature and financial effect of the business
      combination. SFAS No. 141(R) is effective for fiscal years beginning after
      December 15, 2008. Earlier adoption is prohibited. The Company is currently
      evaluating the potential impact, if any, of the adoption of FAS 141(R) on its
      consolidated financial statements.





In
      December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
      Consolidated Financial Statements - an amendment of ARB No. 51.” SFAS No. 160
      establishes accounting and reporting standards pertaining to ownership interests
      in subsidiaries held by parties other than the parent, the amount of net income
      attributable to the parent and to the noncontrolling interest, changes in a
      parent’s ownership interest, and the valuation of any retained noncontrolling
      equity investment when a subsidiary is deconsolidated. This Statement also
      establishes disclosure requirements that clearly identify and distinguish
      between the interests of the parent and the interests of the noncontrolling
      owners. SFAS No. 160 is effective for fiscal years beginning on or after
      December 15, 2008.




F-21




**BLUEPHOENIX
      SOLUTIONS LTD.**




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**Note
      1 - Summary of Significant Accounting Policies (Cont.):**




**W.**
            **Recently
                Issued Accounting Pronouncements
                (cont.):**




In
      December 2007, the SEC issued Staff Accounting Bulleting No. 110 ("SAB 110")
      relating to the use of a "simplified" method in developing an estimate of the
      expected term of "plan vanilla" share options. SAB 107 previously allowed the
      use of the simplified method until December 31, 2007. SAB 110 allows, under
      certain circumstances, to continue to accept the use of the simplified method
      beyond December 31, 2007. The adoption of SAB 110 will impact the consolidated
      financial statements since the Company uses the "simplified" method in
      developing an estimate of the expected term on its share options.




**Note
      2 - Certain Transactions:**




In
      order
      to enhance the Company’s solutions and services portfolio, the Company has been
      pursuing a strategy of adding new technologies to its suite of automated
      modernization tools. The Company implements this strategy via internal
      development of new software tools and through acquisitions and investments.
      Accordingly, the Company invests in businesses that develop software tools
      that
      are complementary to its existing portfolio.




**A.**
            **Amalgamated
                Software North America
                (ASNA):**




In
      August
      2007, the Company entered into an agreement to purchase 100% of the outstanding
      share capital of Amalgamated Software North America Inc. (ASNA), a private
      company based in San Antonio, Texas, for a total consideration of $7 million.
      Under the terms of the transaction, the company agreed to pay the selling
      shareholders an additional consideration if certain criteria are met based
      on
      ASNA's earnings before interest and taxes referred to as EBIT for the period
      from August 15, 2007 to December 31, 2007. For such period the Company accrued
      a
      contingent consideration in the amount of $746 thousand which was recorded
      as
      goodwill. For the years 2008 and 2009 the Company shall be required to pay
      to
      the selling shareholders an additional amount, calculated incrementally, based
      on a multiplier of between 6.5 times to 8 times of ASNA's average net profit
      in
      2008 and 2009, if the average annual net profit during these years two years
      exceeds a certain level.




ASNA’s
      product, Monarch, is a fully integrated solution for transforming RPG
      applications to the Microsoft NET platform. ASNA is a Microsoft Gold Certified
      Partner, a Microsoft Visual Studio Industry Partner, an IBM Tools Network
      Partner, and an Advanced Tier Member of IBM’s PartnerWorld. Through the
      acquisition, BluePhoenix expects to expand its modernization offering to
      enterprises running legacy applications on the IBM AS/400, iSeries, and System
      i
      who are facing the mounting challenge of modernizing their RPG-based
      applications, by providing these enterprises both software tools and services
      required to perform these tasks successfully.




F-22




**BLUEPHOENIX
      SOLUTIONS LTD.**




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**Note
      2 - Certain Transactions (Cont.):**




**A.**
            **Amalgamated
                Software North America (ASNA)
                (cont.):**




The
      acquisition was accounted for by the purchase method. The results of operations
      of ASNA are included in the consolidated financial statement commencing August
      1, 2007. The consideration of the acquisition was attributed to net assets
      acquired and liabilities assumed based on their fair value. Upon a purchase
      price allocation that hasn’t been finalized, an amount of $1.9 million was
      allocated to core technology and to be amortized over a 5 years period. An
      amount of $1.1 million was allocated to estimated fair value of the customers
      related intangible assets, which is being amortized over its estimated useful
      life - currently 8 years, and an amount of $1.3 million was allocated to other
      intangible assets (mainly brand name) and is being amortized over a 10 years
      period. The excess cost of the acquisition over the fair value of net tangible
      and intangible assets amounted to $ 3.7 million and were allocated to goodwill.
      The future contingent consideration, if established, will be recorded as
      goodwill.





The
      following table summarizes the fair values of assets acquired and liabilities
      assumed as of the date of purchase:




**(in thousands)**Current
                assets
            
            $
            919Investment
                in affiliate company
            
            
            205Property
                and equipment
            
            
            181Brand
                name
            
            
            958Distribution
                agreement
            
            
            359Goodwill
            
            
            3,718Technology
            
            
            1,930Customer
                related intangible asset
            
            
            1,142Total
                tangible and intangible assets acquired
            
            
            9,412Current
                liabilities
            
            
            2,122Total
                liabilities assumed
            
            
            2,122Net
                assets acquired
            
            $
            7,290




F-23


**BLUEPHOENIX
      SOLUTIONS LTD.**




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**Note
      2 - Certain Transactions (Cont.):**




**B.**
            **BridgeQuest
                Inc.**




Effective
      April 2007, the Company entered into an agreement to purchase 100% of the
      outstanding share capital of BridgeQuest Inc., a North Carolina corporation
      that
      manages and operates, through a wholly owned subsidiary, a professional
      outsourcing center in St. Petersburg, Russia. BridgeQuest is experienced in
      providing development services from the Russian Federation. Through this
      alternative large offshore center the Company will offer services at a lower
      cost than other offshore facilities of the Company's in Romania and Cypress.
      The
      consideration amounted to $2 million. Under the terms of the transaction, as
      amended by the parties in January 2008, the Company issued to the selling
      shareholders an option to purchase 200,000 of the Company’s ordinary shares and
      paid the selling shareholders an additional consideration computed based on
      BridgeQuest revenues and earnings before interest and taxes referred to as
      EBIT,
      during the period from April 1, 2007 to December 31, 2007. The contingent
      consideration for 2007 amounted to approximately $1.8 million and was recorded
      as goodwill. In addition, the Company agreed to pay the selling shareholders
      additional consideration calculated incrementally based on a multiplier of
      between 4 times to 5.5 times of BridgeQuest's average operating profit in 2008
      and 2009.





The
      acquisition was accounted for by the purchase method. The results of operations
      of BridgeQuest are included in the consolidated financial statement commencing
      April 1, 2007. The consideration of the acquisition was attributed to net assets
      acquired and liabilities assumed based on their fair value. Based on a of a
      purchase price allocation, an amount of $0.5 million was allocated to core
      technology and to be amortized over a 5 years period. An amount of $0.7 million
      was allocated to estimated fair value of the customers related intangible
      assets, which is being amortized over its estimated useful life - currently
      8
      years. The excess cost of the acquisition over the fair value of net tangible
      and intangible assets amounted to $ 2.3 million and was allocated to goodwill.
      The future contingent consideration, if established, will be recorded as
      goodwill.




F-24




**BLUEPHOENIX
      SOLUTIONS LTD.**




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**Note
      2 - Certain Transactions (Cont.):**




**B.**
            **BridgeQuest
                Inc. (cont.)**




The
      following table summarizes the fair values of assets acquired and liabilities
      assumed as of the date of purchase:




**(in thousands)**Current
                assets
            
            $
            522Property
                and equipment
            
            
            122Goodwill
            
            
            2,257Technology
            
            
            493Customer
                related intangible asset
            
            
            682Total
                tangible and intangible assets acquired
            
            
            4,076Current
                liabilities
            
            
            1,795Other
                long-term liabilities
            
            
            185Total
                liabilities assumed
            
            
            1,980Net
                assets acquired
            
            $
            2,096





**C.**
            **CodeStream
                Software Ltd.:**




In
      December 2006, the Company acquired from a company incorporated in the United
      Kingdom, CodeStream Software Ltd., certain business activities in the field
      of
      modernization of legacy databases, particularly IDMS and other mainframe
      platforms. Pursuant to the purchase agreement, the Company hired 18 persons
      previously employed by CodeStream and assumed all the obligations in respect
      of
      the purchased activities. In consideration thereof the Company paid CodeStream **₤** 5.2
      million (approximately $10.2 million). Pursuant
      to the purchase agreement, as amended in December 2007, the
      Company committed to pay CodeStream £425 thousand (approximately $842 thousand)
      out of which £390 thousand (approximately $800 thousand) was already paid.
      Additional consideration of $300 thousand was paid in January 2008 and $1
      million to be paid in October 2008. Consequently, an amount of $2.1 million
      was
      recorded as contingent consideration against goodwill. In addition, as a
      contingent consideration for the purchased activity, the Company undertook
      to
      issue to the selling shareholders 400,000 BluePhoenix ordinary shares by March
      31, 2008 and an additional 600,000 ordinary shares by March 31, 2009, if certain
      conditions are met during such period. In the event that the volume weighted
      average price per ordinary share on the NASDAQ Global Market during a
      consecutive 10-day trading period is less than $6.00, the grantees of such
      shares may request cash payments of £1.2 million (approximately $2.3 million)
      and £1.7 million (approximately $3.4 million), respectively, in lieu of the
      issuances of ordinary shares.




F-25




**BLUEPHOENIX
      SOLUTIONS LTD.**




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**Note
      2 - Certain Transactions (Cont.):**




**C.**
            **CodeStream
                Software Ltd.:**




Since
      CodeStream's activity constitutes a "business" in accordance with EITF 98-3
      "Determining Whether a Non-monetary Transaction Involves Receipt of Productive
      Assets of a Business", the acquisition was accounted under the guidelines of
      SFAS 141 "Business Combinations".





The
      acquisition was accounted for by the purchase method. The consideration of
      the
      acquisition was attributed to net assets acquired and liabilities assumed based
      on their fair value. Based on a purchase price allocation, an amount of $4.6
      million was allocated to core technology and to be amortized over a 5 years
      period. An amount of $0.5 million was allocated to estimated fair value of
      the
      customers related intangible assets, which is being amortized over its estimated
      useful life - currently 8 years. The excess cost of the acquisition over the
      fair value of net tangible and intangible assets amounted to $ 5.8 million
      and
      was allocated to goodwill. The future contingent consideration, if established,
      will be recorded as goodwill.





The
      following table summarizes the fair values of assets acquired and liabilities
      assumed as of the date of purchase:




**(in thousands)**Current
                assets
            
            $
            44Property
                and equipment
            
            
            285Goodwill
            
            
            5,778Technology
            
            
            4,600Customer
                related intangible asset
            
            
            470Total
                tangible and intangible assets acquired
            
            
            11,177Current
                liabilities
            
            
            304Total
                liabilities assumed
            
            
            304Net
                assets acquired
            
            $
            10,873





**D.**
            **Intercomp:**




In
      1998,
      the Company initially invested in Intercomp Ltd, which has developed a set
      of
      automated analysis and reengineering tools for legacy COBOL applications.
      Following a series of subsequent transactions, in which the Company issued
      Infinity 100,719 of BluePhoenix ordinary shares in the first quarter of 2007
      at
      the fair value of $515 thousand, the Company currently wholly owns Intercomp.




F-26


**BLUEPHOENIX
      SOLUTIONS LTD.**




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**Note
      2 - Certain Transactions (Cont.):**




**D.**
            **Intercomp
                (cont.):**




In
      the
      first quarter of 2006, First Israel Mezzanine Investors Ltd., FIMI, a creditor
      of Intercomp, has completed exercising a put option to sell the Company a
      convertible promissory notes issued by Intercomp, in an aggregate principal
      amount of $3.5 million. The put option was originally granted to FIMI in January
      2001. As consideration thereof, the Company paid FIMI In the first quarter
      of
      2006 an aggregate amount of $4.48 million including interest accrued, which
      equals the book value of the promissory notes, and issued to FIMI warrants
      to
      purchase 210,000 BluePhoenix ordinary shares at an exercise price of $4.00
      per
      share. No gain or loss was recorded at the repayment date. In the first quarter
      of 2007 FIMI exercised the warrants for a total exercise price of $840
      thousand.





**E.**
            **I-Ter/Informatica
                & Territorio S.p.A.:**




In
      the
      second quarter of 2005, the Company entered into an agreement to purchase the
      entire outstanding share capital of I-Ter/Informatica & Territorio S.p.A.
      (“I-Ter”). Pursuant to the purchase agreement, the Company paid to the selling
      shareholders of I-Ter $1.4 million. In addition, under the terms of the
      transaction, the Company agreed to pay the selling shareholders an additional
      contingent consideration based on I-Ter’s earnings before interest and taxes,
      for the years 2005 through 2007. The accrued contingent consideration was
      calculated on December 31, 2007 and amounted to $5.1 million which was recorded
      as goodwill and of which $480 thousand have been paid as of December 31,
      2007.





**F.**
            **Outlook:**




Effective
      as of January 2004, the Company acquired from an Israeli Company, Outlook
      Systems Ltd. through a new wholly-owned subsidiary, Outlook & BluePhoenix
      Ltd., Outlook Systems’ entire business activities in Israel in the field of
      research and development services. Pursuant to the purchase agreement, the
      Company hired 31 employees previously employed by Outlook Systems and assumed
      all the obligations in respect of the purchased activity. Under the purchase
      agreement, as amended in 2006, the Company paid to Outlook Systems an aggregate
      amount of approximately $1.3 million. In accordance with the amendment to the
      purchase agreement, a guarantee given by the Company to secure bank loans of
      Outlook Systems was cancelled, and Outlook Systems received in 2006 138,591
      of
      BluePhoenix’s ordinary shares. Additional consideration for the amount of $174
      thousand was due and paid in 2007. In addition, under the terms of the
      agreement, the Company agreed to pay the selling shareholders an additional
      contingent consideration based on Outlook’s earnings before interest and taxes
      for the three years commencing on July 1, 2005. The accrued contingent
      consideration amounted to $20 thousand for the year 2007 and was recorded as
      goodwill




F-27


**BLUEPHOENIX
      SOLUTIONS LTD.**




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**Note
      2 - Certain Transactions (Cont.):**




**G.**
            **Zulu
                Software Inc.:**




In
      February 2005, the Company entered into an agreement to purchase up to 20%
      of
      the outstanding share capital of Zulu Software, Inc. (“Zulu”), on a fully
      diluted basis. Under the purchase agreement, the purchase price was divided
      into
      four installments, each to be paid subject to fulfillment of certain milestones.
      The company paid the first installment of $350 thousand in February 2005 against
      the issuance of 8% of Zulu’s outstanding share capital. The Company did not make
      additional payments since the agreed upon milestones have not been
      met.





In
      January 2006, the Company purchased from the other shareholders of Zulu
      additional shares increasing its holdings to 72% of Zulu’s outstanding share
      capital. The aggregate consideration paid for this additional purchase was
      $2.4
      million.





The
      consideration for the acquisition was attributed to net assets on the basis
      of
      fair value of assets acquired and liabilities assumed. Based on a purchase
      price
      allocation, the purchase price was allocated to the purchased technology in
      the
      amount of $3.5 million, and is amortized over a 5-year period.




**H.**
            **Unaudited
                Pro Forma Information:**




The
      following unaudited pro forma summary presents information as if the acquisition
      of BridgeQuest and Asna had occurred as of January 1, 2007 and 2005, and as
      if
      the acquisition of Zulu and CodeStream’s activity had occurred as of January 1,
      2006 and 2005. The pro forma information, which is provided for informational
      purposes only, is based on historical information and does not necessarily
      reflect the results that would have occurred, not is it necessarily indicative
      of future results of operations of the consolidated entity.





**Year
                ended****December
                31,****2007**
            
            **2006**
            
            **2005****(In
                thousands, except per share data)****(Unaudited)**Revenues
            
            $
            92,868
            
            $
            80,696
            
            $
            61,301Net
                income (loss)
            
            $
            (10,675
            )
            $
            3,751
            
            $
            (1,618
            )Earning
                (loss) per share – basic
            
            $
            (0.62
            )
            $
            0.27
            
            $
            (0.12
            )Earning
                (loss) per share – diluted
            
            $
            (0.62
            )
            $
            0.26
            
            $
            (0.12
            )




F-28


**BLUEPHOENIX
      SOLUTIONS LTD.**




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**Note
      3 - Property and Equipment, Net:**




Composition
      of property and equipment, grouped by major classifications:




**December
                31,****2007**
            
            **2006****(in
                thousands)****Cost:**Computers
                and peripheral equipment
            
            $
            10,342
            
            $
            9,887Office
                furniture and equipment
            
            
            1,572
            
            
            1,268Leasehold
                improvements
            
            
            594
            
            
            645Motor
                vehicles
            
            
            305
            
            
            29212,813
            
            
            12,092**Accumulated
                Depreciation:**Computers
                and peripheral equipment
            
            
            8,777
            
            
            8,565Office
                furniture and equipment
            
            
            981
            
            
            874Leasehold
                improvements
            
            
            358
            
            
            398Motor
                vehicles
            
            
            163
            
            
            10810,279
            
            
            9,945**Depreciated
                cost**
            
            $
            2,534
            
            $
            2,147





Depreciation
      expenses totaled $990, $849, and $1,058 thousand for the years ended December
      31, 2007, 2006, and 2005, respectively.





**Note
      4 - Goodwill:**




**December
                31,****2007**
            
            **2006****(in
                thousands)**Carrying
                amounts at beginning of year
            
            $
            44,838
            
            $
            38,832Acquired
                (1)
            
            
            15,856
            
            
            6,006Impairment
                (2)
            
            
            (6,989
            )
            
            -Carrying
                amount at end of year
            
            $
            53,705
            
            $
            44,838





(1)  Including
      contingent consideration.


(2)  Related
      to Goodwill of Mainsoft Corporation.




F-29




**BLUEPHOENIX
      SOLUTIONS LTD.**




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**Note
      5 - Intangible Assets and Others, Net:**




**Composition:**





**December
                31,****2007**
            
            **2006****(in
                thousands)****Original
                amount:**Technology
            
            $
            62,965
            
            $
            55,430Customer
                related intangible assets
            
            
            3,569
            
            
            1,576Deferred
                issuance expenses, net
            
            
            -
            
            
            738Distribution
                agreement related intangible assets
            
            
            359
            
            
            -Brand
                name related intangible assets
            
            
            958
            
            
            -Deferred
                tax asset
            
            
            790
            
            
            -Others
            
            
            145
            
            
            19868,786
            
            
            57,942**Accumulated
                amortization:**Technology
            
            
            31,066
            
            
            20,607Customer
                related intangible assets
            
            
            982
            
            
            509Distribution
                agreement related intangible assets
            
            
            24
            
            
            -Brand
                name related intangible assets
            
            
            32
            
            
            -Other
            
            
            109
            
            
            -32,213
            
            
            21,116$
            36,573
            
            $
            36,826





Intangible
      assets amortization expenses totaled $11.1 million, $7.1 million and $5.5
      million for the years ended December 31, 2007, 2006, and 2005,
      respectively.




The
      estimated aggregate amortization of customer related intangible asset for the
      following years is as follows: 2008: $488 thousand, 2009: $436 thousand, 2010:
      $371 thousand, 2011, and 2012: $319.




The
      estimated aggregate amortization of distribution agreement related intangible
      asset for the following years is as follows: 2008 through 2012: $33
      thousands.




The
      estimated aggregate amortization of brand name related intangible asset for
      the
      following years is as follows: 2008 through 2012: $96 thousands.




F-30




**BLUEPHOENIX
      SOLUTIONS LTD.**




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**Note
      6 - Short-Term Bank Credit and Other:**


**Composition:**





**December
                31,**%
            
            **Linkage**
              **Basis**
            
            **2007**
            
            **2006****(in
                thousands)**Bank
                overdraft and loans
            
            
            7.5
            
            
            NIS
            
            
            -
            
            $
            27Short-term
                bank loans
            
            
            5.98
            
            
            Euro
            
            
            -
            
            
            55Current
                portion of long-term bank loan
            
            
            6.22
            
            
            Euro
            
            
            -
            
            
            527-
            
            $
            609





**Note
      7 - Accrued Severance Pay, Net:**




**A.**
            **Accrued
                Liability:**




The
      Company is liable for severance pay to its employees pursuant to the applicable
      local laws prevailing in the respective countries of employment and employment
      agreements. For Israeli employees, the liability is partially covered by
      individual managers’ insurance policies under the name of the employee, for
      which the Company makes monthly payments. The Company may make withdrawals
      from
      the managers’ insurance policies only for the purpose of paying severance
      pay.





The
      amounts accrued and the amounts funded with managers’ insurance policies are as
      follows:




**December
                31,****2007**
            
            **2006****(in
                thousands)**Accrued
                severance pay
            
            $
            6,292
            
            $
            5,769Less
                - amount funded
            
            
            4,490
            
            
            4,051$
            1,802
            
            $
            1,718





**B.**  **Expenses:**




The
      expenses related to severance pay for the years ended December 31, 2007, 2006,
      and 2005 were $793, $925, and $383 thousand, respectively.




F-31




**BLUEPHOENIX
      SOLUTIONS LTD.**




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**Note
      8 - Provision for Losses in Formerly-consolidated
      Subsidiary:**




Liraz,
      a
      wholly owned subsidiary of the Company, was liable for a credit facility
      guarantee in a former subsidiary it had consolidated until the second quarter
      of
      2001. The provision for such liability as of December 31, 2006 was accounted
      for
      under SFAS 5 and FIN 45 and amounted to $2 million, representing the maximum
      potential amount Liraz has guaranteed to secure a bank loan of the said
      subsidiary.




Pursuant
      to an agreement signed in October 2007 with Cicero, the Company repaid $1.7
      million on behalf of Cicero to cover part of Cicero's credit facility with
      the
      bank. In connection therewith, a $2.0 million bank guarantee that the Company
      previously provided to Bank Ha'Poalim to secure Cicero's bank loans, was
      released. Accordingly, on the repayment date, an amount of $300 thousand was
      charged to earnings.




As
      consideration thereto Cicero issued to the Company (a) a $1.0 million senior
      promissory note, bearing an annual interest rate of LIBOR + 1% (or in the event
      of any unpaid interest, LIBOR + 4%) payable in two installments, the first
      installment of $350 thousand due on January 30, 2009 and the second installment
      of $671 thousand due on December 31, 2011, the Company is entitled to receive
      Cicero's shares instead of any unpaid debt (b) 2,546,149 ordinary shares of
      Cicero. Cicero committed to register these share for trade until certain date,
      otherwise the Company is entitled to additional shares.




As
      of
      December 31, 2007, the Company holds 2,709,922 ordinary shares of Cicero out
      of
      which 2,546,149 are classified as available-for-sale marketable securities
      since
      they are yet to be registered for trading. Unrealized gain amounted to $178
      thousand in 2007 (see also Note 13B5).





**Note
      9 - Loans from Banks and Others:**




**A.** **Composition:**





**December
                31,****2007**
            
            **2006****Average
                Interest rate**
            
            **Linkage**
              **Basis**
            
            **Total
                long-term liabilities**
              **net
                of current portion****%**
            
            
            
            **(in
                thousands)**7.22
            
            
            Dollar
            
            $
            135
            
            $
            10,5546.22
            
            
            Euro
            
            
            -
            
            
            10,000Less
                - current portion
            
            
            
            
            
            -
            
            
            (527
            )$
            135
            
            $
            20,027




F-32




**BLUEPHOENIX
      SOLUTIONS LTD.**




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**




**Note
      9 - Loans from Banks and Others (Cont.):**




**B.**  **Long-term
      Loans from Banks and Other are due as follows:**




**December
                31,****2007**
            
            **2006****(in
                thousands)**First
                year (current portion)
            
            $
            135
            
            $
            527Second
                year
            
            
            -
            
            
            7,558Third
                year
            
            
            -
            
            
            1,620Fourth
                year and thereafter
            
            
            -
            
            
            10,849Total
            
            $
            135
            
            $
            20,554





**Note
      10 - Commitments and Contingencies:**




**A.** **Commitments:**




**1.**
            **Lease.**The Company rents its offices, vehicles and, other equipment under
                various
                operating lease agreements. Rent expenses for the years ended December
                31,
                2007 , 2006 and 2005 were $3 million ,$2.7 million and $2.9 million.
                Aggregate minimum rental commitments under non-cancelable leases
                as of
                December 31, 2007 were as follows:




**Office Facilities**
            
            **Vehicles,**
              **Equipment, and**
              **Other**Fiscal
                2008
            
            $
            2,780
            
            $
            481Fiscal
                2009
            
            
            990
            
            
            211Fiscal
                2010
            
            
            824
            
            
            104Fiscal
                2011
            
            
            564
            
            
            11Thereafter
            
            
            157
            
            
            -$
            5,315
            
            $
            807





**2.**
            **Customers’
                bank guarantees.**Under agreements between the Company and certain of its customers,
                the
                Company undertook to provide such customers a bank guarantee for
                the
                assurance of performance of its obligations under its agreements
                with such
                customers. As of December 31, 2007, there are outstanding bank guarantees
                on behalf of customers in the aggregate amount of $52
                thousand.





**3.**
            **Chief
                Scientist.**Three of the Company’s subsidiaries have entered into agreements with the
                OCS; these subsidiaries are obliged to pay royalties to the OCS at
                a rate
                of 3% on sales of the funded products, up to 100% of the dollar-linked
                grant received in respect of these products from the OCS. As of December
                31, 2007, the contingent liability amounted to $3.1
                million.




F-33




**BLUEPHOENIX
      SOLUTIONS LTD.**




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**Note
      10 - Commitments and Contingencies (Cont.):**




**A.**  **Commitments
      (cont.):**




**4.**
            **Ministry
                of Production in Italy**.
                In July 2007, the Company’s subsidiary, I-Ter, received a final approval
                from the Ministry of Production in Italy for its Easy4Plan product.
                Easy4Plan is a workflow management tool designed for ISO9000 companies.
                The total funds received from the Ministry of Production amounted
                to
                approximately $650,000, of which 30% are a grant, and the balance
                is an
                8-year loan to be repaid by I-Ter. The loan bears a nominal annual
                interest. 90% of the funds were received in December 2007. The remaining
                10% are subject to a final review by the Ministry of
                Production.




**5.**
            **Credit
                lines from banks.**In
                connection with the credit line from Bank Discount Le’Israel Ltd, Bank
                Ha’Poalim Ltd., The First International Bank Ltd. and Bank Leumi Le’Israel
                Ltd., the Company committed to certain covenants related to its operation
                such as:




a)
            Maintaining
                a minimum level of shareholders’ equity of no less than 40% of the
                Company’s total assets and no less than $50
                million;




b)
            Maintaining
                a minimum level of tangible shareholders’ equity of no more than a deficit
                of $30 million;




c)
            Maintaining
                a level of annual operating income before depreciation and amortization
                of
                no less than $5 million; and




d)
            Maintaining
                the ratio of the Company bank liabilities to current assets, excluding
                other current assets, of no more than
                40%.




As
      of
      December 31, 2007 there were no bank credits.




F-34




**BLUEPHOENIX
      SOLUTIONS LTD.**




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**








**Note
      10 - Commitments and Contingencies (Cont.):**




B.
**Contingencies:**


**1.**
              In
                  July 2003, a former Liraz shareholder filed an application with
                  the
                  Tel-Aviv-Jaffa District Court to approve a claim filed by him against
                  the
                  Company, as a class action. The claim relates to the acquisition
                  of Liraz
                  shares that the Company completed in March 2003. The shareholder
                  alleges
                  that the share price that the Company paid to Liraz’s shareholders in the
                  tender offer and in a subsequent mandatory purchase was lower than
                  the
                  fair price of Liraz shares. The maximum amount of the claim is
                  approximately $8.6 million in the aggregate. Under Israeli law,
                  the
                  court’s approval is required for the plaintiff to represent all of the
                  shareholders of Liraz who sold their shareholdings to the Company
                  pursuant
                  to the tender offer and the mandatory acquisition. The plaintiff
                  has
                  applied for such approval in the lawsuit. The Company believes
                  that the
                  allegations against it in this proceeding are without merit and
                  intends to
                  vigorously defend the claim and contest the allegations made
                  therein.




**2.**
            The
                Company evaluates estimated losses for indemnifications due to product
                infringement under SFAS No. 5, “Accounting for Contingencies,” as
                interpreted by FIN 45. At this time, it is not possible to determine
                the
                maximum potential amount under these indemnification clauses due
                to lack
                of prior indemnification claims and the unique facts and circumstances
                involved in each particular agreement. Such indemnification agreements
                may
                not be subject to maximum loss clauses. Historically, the Company
                has not
                incurred material costs as a result of obligations under these agreements
                and has not accrued any liabilities related to such indemnification
                obligations in our financial
                statements.





**Note
      11 - Shareholders’ Equity:**




**A.** **Share
        Capital:**




**1.**
            On
                January 31, 1997, the Company's ordinary shares were first offered
                in an
                initial public offering. Since this transaction, the Company’s shares have
                been traded in the United States on the NASDAQ Global Market. Their
                current symbol is “BPHX.”




In
      January 2001, the Company's ordinary shares were listed for trading on the
      Tel-Aviv stock Exchange under the "Dual Listing" arrangement. Ordinary share
      confers upon their holders the rights to receive notice to participate and
      vote
      in general meeting of the Company, and the right to receive dividends if
      declared.




F-35




**BLUEPHOENIX
      SOLUTIONS LTD.**




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**Note
      11 - Shareholders’ Equity (Cont.):**




**A.** **Share
        Capital (cont.):**




**2.**
            Two
                subsidiaries of the Company hold a total of 1,647,594 of Company’s shares
                in a total consideration of $13.5 million. All of the Company’s ordinary
                shares have equal voting rights. However, under applicable Israeli
                law,
                the shares held by the Company’s subsidiaries have no voting rights and,
                therefore, are excluded from the number of its outstanding shares.




**3.**
            In
                the first quarter of 2007 FIMI exercised 210,000 warrants and 100,715
                ordinary shares were issued to Infinity (see Note
                2E).




**4.**
            In
                November 2007, the Company completed a $35 million private placement
                of
                ordinary shares and warrants issued to institutional investors. Under
                the
                Securities Purchase Agreement entered into with the institutional
                investors, the Company sold to the investors 1,999,998 ordinary shares
                at
                a purchase price of $17.50 per share. The investors were also granted
                warrants to purchase 800,000 ordinary exercisable during a 5-year
                term at
                an exercises price of $21.88. As agreed with the investors, the Company
                registered the shares purchased by the investors and those underlying
                the
                warrants for resale under an effective registration statement.




The
      shares and warrants overcome all criteria set forth in SFAS 133 “Accounting for
      Derivative Instruments and Hedging Activities" and EITF 00-19 “Accounting
      for Derivative Financial Instruments Indexed to, and Potentially Settled In,
      a
      Company’s Own Stock” . In
      addition, the commitment to register the shares and to keep the filling in
      effect was analyzed pursuant to the FSP EITF 00-19-2 “Accounting for
      Registration Payment Arrangements" and was accordingly determined under the
      provision of SFAS 5. As of the balance sheet date the Company has not recorded
      a
      liability thereof.




The
      proceeds amount net of issuance costs totaled $33 million and was recorded
      in
      equity.





**B.** **Share
        Options:**




**1.**
            **Employee
                Share Option Plans:**




On
      December 31, 2007, the Company had two share-based compensation plans: (a)
      the
      1996 share option plan. (b) The 2007 Restricted Share Units plan. Both plans
      are
      described below. The compensation costs that were charged to income for those
      plans amounted to $1,025 thousand and $40 thousand for 2007 and 2006
      respectively.




F-36




**BLUEPHOENIX
      SOLUTIONS LTD.**




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**Note
      11 - Shareholders’ Equity (Cont.):**




**B.** **Share
        Options (cont.):**




**1.**
            **Employee
                Share Option Plans
                (cont.):**




**a)**
            **The
                1996 Share Option Plan:**




In
      1996,
      the Company adopted two option plans. One of these option plans was terminated
      after all options granted under it were exercised. Pursuant to the other 1996
      option plan, as amended, the Company reserved 3,700,000 ordinary shares for
      issuance to directors, officers, consultants and employees of the Company and
      its subsidiaries. The exercise price of the options granted under the 1996
      option plan ranges from $2.25 to $10.50.




Under
      the
      1996 option plan, unless determined otherwise by the Board, options vest over
      a
      three to four years period from the date of grant and expire 10 years after
      grant date. Unvested options are forfeited 30-90 days following termination
      of
      employment. Any options that are forfeited before expiration become available
      for further grants.




The
      following table summarizes information about share options outstanding and
      exercisable as of December 31, 2007:




**Options
                Outstanding**
            
            **Options
                Exercisable****Exercise**
              **Prices**
            
            **Number
                Outstanding on December 31, 2007**
            
            **Weighted
                Average Remaining Contractual Life**
            
            **Number
                Exercisable on December 31, 2007**
            
            **Exercise
                Price****$**
            
            
            
            **Years**
            
            
            
            **$**2.25
            
            
            375,000
            
            
            5.25
            
            
            375,000
            
            
            2.253.00
            
            
            79,510
            
            
            5.50
            
            
            79,510
            
            
            3.003.00
            
            
            45,800
            
            
            4.09
            
            
            45,800
            
            
            3.004.00
            
            
            200,000
            
            
            5.83
            
            
            200,000
            
            
            4.004.00
            
            
            150,000
            
            
            8.00
            
            
            100,000
            
            
            4.004.50
            
            
            17,350
            
            
            3.50
            
            
            17,350
            
            
            4.504.50
            
            
            4,000
            
            
            7.67
            
            
            4,000
            
            
            4.505.00
            
            
            149,085
            
            
            8.00
            
            
            148,951
            
            
            5.005.50
            
            
            39,168
            
            
            8.58
            
            
            7,168
            
            
            5.506.00
            
            
            10,000
            
            
            6.00
            
            
            10,000
            
            
            6.006.00
            
            
            69,051
            
            
            6.42
            
            
            65,717
            
            
            6.006.00
            
            
            150,000
            
            
            7.67
            
            
            150,000
            
            
            6.009.63
            
            
            3,000
            
            
            2.25
            
            
            3,000
            
            
            9.6310.50
            
            
            60,300
            
            
            3.25
            
            
            60,300
            
            
            10.501,352,264
            
            
            
            
            
            1,266,796




F-37




**BLUEPHOENIX
      SOLUTIONS LTD.**




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**Note
      11 - Shareholders’ Equity (Cont.):**




**B.** **Share
        Options (cont.):**




**1.**
            **Employee
                Share Option Plans
                (cont.):**




**a)**
            **The
                1996 Share Option Plan
                (cont.):**




Data
      related to the share option plan as of December 31, 2007, 2006 and 2005 and
      changes during the years ended on those dates are as follows:




**2007**
            
            **2006**
            
            **2005****Number
                of Options**
            
            **Weighted
                Average Exercise Price**
            
            **Number
                of Options**
            
            **Weighted
                Average Exercise Price**
            
            **Number
                of Options**
            
            **Weighted
                Average Exercise Price**$
            
            
            
            $
            
            
            
            **$**Options
                outstandingat
                beginning of year
            
            
            2,222,967
            
            
            4.60
            
            
            2,765,817
            
            
            4.78
            
            
            2,132,587
            
            
            5.00Changes
                during the year:Granted
            
            
            -
            
            
            -
            
            
            75,000
            
            
            5.50
            
            
            834,712
            
            
            4.96Exercised
            
            
            (575,766
            )
            
            5.07
            
            
            (206,796
            )
            
            3.53
            
            
            (10,299
            )
            
            3.05Forfeited
            
            
            (294,937
            )
            
            5.89
            
            
            (411,054
            )
            
            6.19
            
            
            (191,183
            )
            
            8.04Options
                outstanding
              at
                end of year
            
            
            1,352,264
            
            
            4.22
            
            
            2,222,967
            
            
            4.60
            
            
            2,765,817
            
            
            4.78Options
                exercisable at year-end
            
            
            1,266,796
            
            
            4.2
            
            
            2,017,300
            
            
            4.71
            
            
            2,399,484
            
            
            4.78Weighted-average
                fair value of options granted during the year*
            
            
            -
            
            
            
            
            
            2.65
            
            
            
            
            
            1.47





*
            The
                fair value of each option granted is estimated on the date of grant,
                using
                the Black-Scholes option-pricing model with the following weighted
                average
                assumptions: dividend yield of 0% for all years; expected volatility:
                2006
                - 45%, 2005 - 41%, risk-free interest rate: 2006- 4.97%, 2005 - 3.93%;
                and
                expected life: 2006 and 2005 - 5.5
                years.




The
      aggregate intrinsic value of outstanding and exercisable options at December
      31,
      2007 was
      $18.8
      million and $17.6 million thousand, respectively.




The
      Company is required to assume a dividend yield as an input in the Black-Scholes
      model. The dividend yield assumption is based on the Company’s historical
      experience and expectation of future dividends payouts and may be subject to
      change in the future.




F-38




**BLUEPHOENIX
      SOLUTIONS LTD.**




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**




**Note
      11 - Shareholders’ Equity (Cont.):**




**B.**
            **Share
                Options (cont.):**




**1.**
            **Employee
                Share Option Plans
                (cont.):**




**a)**
            **The
                1996 Share Option Plan
                (cont.):**




The
      Company uses historical volatility in accordance with FAS 123R. The computation
      of volatility uses historical volatility derived from the Company’s
      exchange-traded shares.




The
      risk-free interest assumption is the implied yield currently available on U.S.
      Treasury zero-coupon bonds, issued with a remaining term equal to the expected
      life term of the Company’s options.




As
      permitted by SAB 107, the Company used the simplified method to compute the
      expected option term for options granted in 2006. As of December 31, 2007 onward
      the Company will adopt SAB 110 in developing an estimate of the expected
      term.





**b)**
            **Acceleration:**




In
      anticipation of the effects that adoption of SFAS No. 123R would
      have, and
      under the Company’s management belief that in the currently increasing
      competition in the labor market, an acceleration may have a positive effect
      on
      employee morale and retention, the
      Compensation Committee and Board of Directors approved and made effective on
      December 27, 2005 the acceleration of several unvested stock options. As a
      result, 144,990 and 1,228,997 unvested stock options were accelerated in the
      Company and in its subsidiary, respectively.





**c)**
            **Employee
                option plan in a
                subsidiary:**




MainSoft
      granted options to its employees to purchase the subsidiary's shares. The
      options are exercisable during a 3 year period after the date of grant. Total
      options outstanding and exercisable as of December 31, 2007 and 2006 were
      4,061,051 and 4,383,987 respectively and the weighted average exercise price
      is
      $0.84. MainSoft did not grant stock options during these two years.




F-39




**BLUEPHOENIX
        SOLUTIONS LTD.**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**


**Note
      11- Shareholders’ Equity (Cont.):**




**B.**
            **Share
                Options (cont.):**




**2.**
            **Restricted
                Share Units (RSU):**




In
      2007,
      the Company adopted a Restricted Share Units plan (RSU). Under the RSU plan,
      as
      amended, the Company granted in 2007 179,500 RSUs. Under the RSU plan, unless
      determine otherwise by the board of directors, RSUs vest over a three years
      period from the date of the grant and expire 10 years after grant date. Unvested
      RSUs are forfeited 30 days after termination of employment.





During
      the forth quarter the Company accelerated the vesting period of 15,833 RSUs
      for
      an immediate vesting. The Company accounted for the acceleration in accordance
      with SFAS 123R and as such calculated the fair value of the RSUs on the
      acceleration date which resulted in an immediate incremental compensation costs
      to that fair value in the amount of $322 thousand.





Data
      related to the restricted share units as of December 31, 2007 and changed during
      the year are as follows:




**Year ended**
              **December 31,**
              **2007**RSUs
                outstanding at the beginning of the year
            
            
            -Changes
                during the year 2007:Granted
                *
            
            
            179,500Exercised
            
            
            (15,833
            )Forfeited
            
            
            -RSUs
                outstanding at the end of the year
            
            
            163,667





*****
            The
                fair value of RSUs is established based on the market value of the
                Company’s stock on the date of the award in accordance with SAB107, less
                an estimate of dividends that will not accrue to RSU holders prior
                to
                vesting. The weighted average fair value of RSUs at grant date was
                $15.1




F-40




**BLUEPHOENIX
        SOLUTIONS LTD.**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**


**Note
      11 - Shareholders’ Equity (Cont.):**




**B.**
            **Share
                Options (cont.):**




**3.**
            **Convertible
                Debentures and Warrants:**




On
      March
      30, 2004, the Company completed a $5 million private placement of convertible
      debentures and warrants to institutional investors.




Under
      the
      terms of this transaction, as amended on February 18, 2005, the company issued
      the institutional investors convertible debentures which were due in 2007,
      bearing interest at a rate equal to six-month LIBOR paid quarterly. The
      debentures were converted into BluePhoenix’s ordinary shares at a conversion
      rate of $5.25 per ordinary share. Following an event of adjustment in January
      2006, the conversion rate of the debentures was adjusted to $5.24 per ordinary
      share.





In
      addition to the debentures, the institutional investors were issued warrants
      to
      purchase up to 285,714 BluePhoenix ordinary shares at an exercise price of
      $6.50
      per share. The warrants are exercisable during a 5-year period commencing
      September 2004.




As
      agreed
      with the investors, the registered shares underlying the debentures and warrants
      were registered for resale under the effective registration statement. In
      accordance with APB No. 14, “Accounting for Convertible Debt and Debt Issued
      with Stock Purchase Warrants,” EITF 98-5, “Accounting for Convertible Securities
      with Beneficial Conversion Features or Contingently Adjustable Conversion
      Rations,” and EITF 00-27, “Application of Issue No. 98-5 to Certain Convertible
      Instruments” (“EITF 00-27”), a portion of the proceeds of the convertible
      debentures issued with detachable warrants was allocated to the warrants and
      to
      the convertible instrument at the time of issuance. Amounts allocated to the
      warrants were accounted for as liabilities, in accordance with EITF 00-19,
      “Accounting for Derivative Financial Instruments Indexed to, and Potentially
      Settled In, a Company’s Own Stock,” and were revalued ,
      based
      on the fair values of the underlying shares, on each reporting date, against
      financial expenses (income).




Since
      any
      future dilutive issuance is under the control of the Company, and the
      anti-dilution adjustment is limited, the Company accounted the debentures as
      conventional convertible instruments.




As
      a
      result, at the issuance date, a beneficial conversion feature was recorded
      on
      the debentures, in the amount of $173 thousand, since the effective conversion
      price of the debentures was lower than the fair value of the shares on the
      commitment date.




F-41


**BLUEPHOENIX
        SOLUTIONS LTD.**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**


**Note
      11 - Shareholders’ Equity (Cont.):**




**B.**
            **Share
                Options (cont.):**




**3.**
            **Convertible
                Debentures and Warrants
                (cont.)**




The
      Company applied EITF 96-19 “Debtor’s Accounting for a Modification or Exchange
      of Debt Instruments” and EITF 05-7 “Accounting of Modification to Conversion
      Option Embedded in Debt Securities and Related Issues” to determine the
      accounting for the modification on February 18, 2005. The change in the term
      of
      the convertible debentures was accounted for as a modification of the instrument
      as a result of the application of the 10% test on the modified debenture and
      the
      original debenture. As a result the change in the debt instrument is not
      considered substantially different (less then 10%).




A
      new
      effective interest rate was determined based on the carrying amount of the
      original debt instrument and the revised cash flows. The deemed discount of
      the
      debentures is deducted from the liability and the issuance expenses, which
      are
      recorded as an asset, and is amortized using the interest method over a period
      of 44 months, the term of the debentures.





The
      difference between the fair value of the conversion option immediately following
      such modification and the fair value immediately prior to the modification,
      was
      recognized as a discount associated with the debt, and the offset to the
      discount was recognized in equity in accordance with EITF 05-7 in the amount
      of
      $325 thousand. The difference between the fair value of the modified warrants
      and the fair value of the original warrants (the warrants are revaluated based
      on the fair values of the underling shares) was deducted from the warrant
      derivative against a discount. The financial expense relating to the
      amortization of the discount of the debentures amounted to $276, $303 and $58
      thousand for the years ended December 31, 2005, 2006 and 2007,
      respectively.




On
      March
      15, 2005, as the Form F-3 relating to the convertible debentures was declared
      effective by the Securities Exchange Commission, the Company classified the
      fair
      value attributed to the warrants as equity. The warrants were revaluated to
      their fair value until such date.




As
      of the
      end of fiscal 2007 second quarter all the debentures were converted to
      BluePhoenix' ordinary shares. Any unamortized discount related to the warrants
      and the beneficial conversion features was charged to financial expenses on
      conversion date.





Pursuant
      to the Company’s agreement with the institutional investors, in March 2006,
      three of the investors exercised their right to purchase additional debentures
      and warrants. Accordingly, the Company issued to the investors debentures in
      an
      aggregate purchase price of $3 million on the same terms as the initial
      debentures, except that the conversion price is $4.50 per share and is due
      in
      2009.




F-42


**BLUEPHOENIX
        SOLUTIONS LTD.**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**


**Note
      11 - Shareholders’ Equity (Cont.):**




**B.**
            **Share
                Options (cont.):**




**3.**
            **Convertible
                Debentures and Warrants
                (cont.)**




In
      addition, the institutional investors were issued additional warrants on the
      same terms as the initial warrants, to purchase an aggregate of up to 200,000
      BluePhoenix ordinary shares. The warrants are exercisable during a 5-year period
      commencing on September 2006.




In
      the
      event that the volume weighted average price per ordinary share (as calculated
      in the preceding sentence) for any 20 consecutive trading days exceeds $5.625,
      the Company may force the holders of the debentures to convert any or all of
      the
      principal amount of the debentures held by them as of such date, subject to,
      among other things, the Company having an effective resale registration
      statement at such time for the resale of the ordinary shares underlying the
      debentures.




In
      accordance with APB No. 14, "Accounting for Convertible Debt and Debt Issued
      with Stock Purchase Warrants", a portion of the proceeds of the convertible
      debentures issued with detachable warrants was allocated to the warrants and
      to
      the convertible instrument at the time of issuance. Amounts allocated to the
      warrants were accounted for as liabilities, in accordance with EITF 00-19,
      "Accounting for Derivative Financial Instruments Indexed to, and Potentially
      Settled In, a Company's Own Stock," and were revalued, based on the fair values
      of the underlying shares, on each reporting date, against financial expenses
      (income).




Since
      the
      debentures include an anti-dilution adjustment and the conversion price is
      not
      fixed, the Company recorded the embedded conversion feature at fair value in the amount of $1.35 million at issuance
      date
      and it's being marked to market in accordance with EITF 00-19 and EITF 05-02
      "Meaning of Conventional Convertible Debt Instrument in Issue No. 00-19".





In
      May
      2006, as the Form
      F-3
      relating to the convertible debentures was declared effective by the Securities
      Exchange Commission, the Company classified the fair value attributed to the
      warrants as equity. The warrants were revaluated to their fair value until
      such
      date.




On
      January 1, 2007 the Company applied FSP EITF 00-19-2 "Accounting for
      Registration Payment Arrangements" and accordingly recorded the difference
      between the embedded conversion derivative and the beneficial conversion feature
      at that date as beginning year equity in the amount of $451
      thousand.





As
      of the
      end of 2007 first quarter all the debentures were converted to the Company's
      ordinary shares and any unamortized discount was charged to financial
      expenses.




F-43




**BLUEPHOENIX
      SOLUTIONS LTD.**




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**




**Note
      11 - Shareholders’ Equity (Cont.):**




**B.**
            **Share
                Options (cont.):**




**4.**
            **Convertible
                Notes**




In
      February 2006, the Company completed an underwritten public offering in Israel
      of series A convertible notes in an aggregate principal amount of NIS 54 million
      that were equal at that time to approximately $11.5 million. The price of the
      notes as determined in the offering was 98% of the principal amount of the
      notes, and the net proceeds from the offering of the notes totaled $11.2
      million. The notes bear interest at a rate of LIBOR 3 months +1.5% per annum.
      The principal and interest of the notes are linked to the U.S. Dollar, with
      a
      minimum rate of the issuance exchange rate.




The
      notes
      are convertible into ordinary shares of BluePhoenix at a conversion rate of
      one
      ordinary share per NIS 26 principal amount of notes, subject to adjustments.
      The
      notes and the shares underling the notes were registered for trade on the TASE.





The
      exchange floor rate was accounted for as an embedded put option and accordingly
      was bifurcated from the host debt contract. The put option was recorded at
      fair
      value on the issuance date and is being marked to model in accordance with
      SFAS
      No 133" Accounting for Derivative Instruments and Hedging Activities". During
      the years 2006 and 2007, financial expenses amounted to $808 and $260 thousand
      respectively in connection with the embedded put option.





As
      of
      December 31, 2007 99.41% of the note were converted to BluePhoenix' ordinary
      shares. Upon conversion, the principal, any unamortized discount were charged
      to
      equity.





In
      January 2008, the TASE notified the Company that the notes will be delisted
      as
      of March 9, 2008, since substantially all of the notes have been converted
      into
      ordinary shares and the minimum holdings requirement is not
      maintained.





**C.**
              **Dividends:**




The
      Company has not paid any cash dividends on its ordinary shares in the past
      and
      does not expect to pay cash dividends on its ordinary shares in the foreseeable
      future.




F-44


**BLUEPHOENIX
        SOLUTIONS LTD.**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**




**Note
      12 - Taxes on Income:**




**A.**
            **Tax
                Benefits under the Law for the Encouragement of Industry (Taxation),
                1969:**




BluePhoenix
      currently qualifies as an “Industrial Company” as defined by this law, and as
      such is entitled to certain tax benefits including, inter-alia, depreciation
      at
      increased rates as stipulated by regulations published under the Inflationary
      Adjustments Law and has the right to deduct for tax purposes, over a period
      of 3
      years, expenses relating to public issuance of shares.





**B.**
            **Tax
                Rate Applicable to Income in
                Israel:**




Taxable
      income for Israeli companies is subject to tax at the rate of 31% in 2006,
      29%
      in 2007, 27% in 2008, 26% in 2009 and 25% in 2010 and thereafter. Deferred
      Income taxes balances were adjusted accordingly and effect of such adjustment
      was not material. This tax rate decrease is not expected to have a material
      effect on the Company’s financial position.





**C.**
            **Deferred
                Income Taxes:**




Deferred
      tax assets reflect the net tax effects of temporary differences between the
      carrying amounts of assets or liabilities for financial reporting purposes
      and
      the amounts used for income tax purposes. As of December 31, 2006 and 2007
      the
      Company’s deferred taxes were in respect of the following:





**December 31,****2007**
            
            **2006****(in thousands)**Net
                operating losses carry forwards
            
            $
            31,797
            
            $
            27,251Research
                and development costs
            
            
            980
            
            
            1,169Provisions
                for employee rights and other temporary differences
            
            
            649
            
            
            824Deferred
                tax assets before valuation allowance
            
            
            33,426
            
            
            29,244Valuation
                allowance
            
            
            (32,390
            )
            
            (29,233
            )Deferred
                tax assets
            
            $
            1,036
            
            $
            11





*
            The
                Company’s management cannot determine whether it is more likely than not
                that the deferred tax asset relating to net operating losses will
                be
                realized.


F-45
  **BLUEPHOENIX
        SOLUTIONS LTD.**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**




**Note
      12 - Taxes on Income (Cont.):**




**D.**
            **Non-Israeli
                Subsidiaries:**




Non-Israeli
      subsidiaries are taxed based upon tax laws in the country of domicile of the
      respective subsidiary.





**E.**
            **Income
                before Taxes on Income is composed as
                Follows:**




**Year ended December 31,****2007**
            
            **2006**
            
            **2005****(in thousands)**Domestic
                (Israel)
            
            $
            (14,953
            )
            $
            3,037
            
            $
            (1,560
            )Foreign
            
            
            6,627
            
            
            1,670
            
            
            3,637$
            (8,326
            )
            $
            4,707
            
            $
            2,077





**F.**
            **Taxes
                on Income Included in the Statements of
                Income:**


**Year ended December 31,****2007**
              
              **2006**
              
              **2005****(in thousands)**For
                  the reported year - current:Domestic
                  (Israel)
              
              $
              276
              
              $
              28
              
              $
              8Foreign
              
              
              609
              
              
              286
              
              
              164885
              
              
              314
              
              
              172Taxes
                  related to prior years
              
              
              208
              
              
              (609
              )
              
              (81
              )Deferred
                  taxes, net
              
              
              (1,025
              )
              
              13
              
              
              58$
              68
              
              $
              (282
              )
              $
              149


**G.**
            **Uncertain
                Tax Position:**




As
      stated
      in Note 1.N, effective January 1, 2007, the Company adopted FIN 48,
“Accounting for Uncertainty in Income Taxes - an interpretation of FAS 109”,
      which was issued in July 2006. FIN 48 clarifies the accounting for uncertainty
      in income taxes and prescribes a recognition threshold and measurement
      attributes for the financial statement recognition and measurement of a tax
      position taken or expected to be taken in a tax return.




As
      a
      result of the implementation of FIN 48, there was no cumulative effect
      adjustment for unrecognized tax benefits, which would have been accounted for
      as
      an adjustment to the January 1, 2007 balance of retained earnings. The Company
      has recorded no liability for income taxes associated with unrecognized tax
      benefits at the date of adoption and have not recorded any liability associated
      with unrecognized tax benefits during 2007. Accordingly, the Company has not
      recorded any interest or penalty in regard to any unrecognized benefit.




F-46




**BLUEPHOENIX
        SOLUTIONS LTD.**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**


**Note
      12 - Taxes on Income (Cont.):**




**G.**
            **Uncertain
                Tax Position:**




The
      Company's policy regarding interest and/or penalties related to income tax
      matters is to recognize such items as a component of income tax expense
      (benefit). The Company does not expect that the amount of unrecognized tax
      benefits will change significantly within the next 12 months.





**H.**
            **A
                reconciliation of the theoretical tax expense, assuming all income
                is
                taxed at the regular rates and the actual tax expense is as
                follows:**




**December 31,****2007**
              
              **2006**
              
              **2005****(in thousands)**Income
                  (loss) before taxes on income, per consolidated statements of
                  income
              
              $
              (8,326
              )
              $
              4,707
              
              $
              2,077Theoretical
                  tax income (expense ) (34% in 2005, and 31% in 2006 and 29% in
                  2007)
              
              
              (2,415
              )
              
              1,459
              
              
              706Decrease
                  in taxes resulting from the following differences:Carry-forward
                  losses and research and development costs for which the Company
                  provided
                  an allowance
              
              
              3,157
              
              
              (1,922
              )
              
              (649
              )Effect
                  of different tax rates in foreign subsidiaries
              
              
              (1,072
              )
              
              407
              
              
              (105
              )Taxes
                  related to previous years
              
              
              208
              
              
              (609
              )
              
              (81
              )State
                  income tax, net of federal benefit
              
              
              19
              
              
              (4
              )
              
              (67
              )Non-deductible
                  expenses
              
              
              171
              
              
              387
              
              
              282Other
              
              
              -
              
              
              -
              
              
              63Taxes
                  on income in the consolidated statements of income for the reported
                  year
              
              $
              68
              
              $
              (282
              )
              $
              149Effective
                  tax rate
              
              
              -
              
              
              -
              
              
              7
              %


**I.**
            **Tax
                Losses:**




The
      Company and its subsidiaries in Israel have NOL carry forwards for income tax
      purposes as of December 31, 2007 totaling $60 million.





**J.**
            **Tax
                Assessments:**




The
      Company received final tax assessments in Israel through tax year
      2003.




F-47




**BLUEPHOENIX
        SOLUTIONS LTD.**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**




**Note
      13 - Supplementary Financial Statement Information:**





**A.**
            **Balance
                Sheets:**




**1.**
            **Trade
                Accounts Receivables:**




**December
                  31,****2007**
              
              **2006****(in
                  thousands)**Trade
                  accounts receivable
              
              $
              25,206
              
              $
              27,156Less
                  provision for doubtful accounts
              
              
              (990
              )
              
              (667
              )$
              24,216
              
              $
              26,489





**2.**
            **Other
                Current Assets:**




**December 31,****2007**
            
            **2006****(in thousands)**Government
                departments and agencies
            
            $
            893
            
            $
            287Advances
                to suppliers and others
            
            
            -
            
            
            140Employees
            
            
            13
            
            
            -Prepaid
                expenses
            
            
            880
            
            
            1,697Related
                parties
            
            
            30
            
            
            30Deferred
                taxes, net
            
            
            105
            
            
            -Short-term
                lease deposits
            
            
            346
            
            
            193Interest
                and other income receivable
            
            
            214
            
            
            749$
            2,481
            
            $
            3,096





**3.**
            **Accounts
                Payable and Accruals -
                Other:**





**December 31,****2007**
            
            **2006****(in thousands)**Government
                departments and agencies
            
            $
            1,109
            
            $
            370Employees
                and wage-related liabilities
            
            
            5,886
            
            
            4,994Contingent
                consideration
            
            
            8,754
            
            
            437Accrued
                expenses and other current liabilities
            
            
            1,111
            
            
            1,128$
            16,860
            
            $
            6,929




F-48




**BLUEPHOENIX
      SOLUTIONS LTD.**




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**Note
      13 - Supplementary Financial Statement Information (Cont):**




**A.**
            **Balance
                Sheets (cont.):**




**4.**
            **The
                Company’s Long-lived Assets are as
                Follows:**




**December 31,****2007**
                  
                  **2006****(in thousands)**Israel
                  
                  $
                  20,676
                  
                  $
                  24,892U.S.A.
                  
                  
                  11,833
                  
                  
                  10,796Europe
                      (other than Denmark)
                  
                  
                  1,512
                  
                  
                  1,590Denmark
                  
                  
                  412
                  
                  
                  501$
                  34,433
                  
                  $
                  37,779




Long-lived
      assets information is based on the physical location of the assets at the end
      of
      each of the fiscal years. The Company does not identify or allocate goodwill
      by
      geographic areas.





**B.**
            **Statements
                of Operations:**




**1.**
            **Geographic
                Areas Information:**




**Sales:
      Classified by Geographic Areas:**




The
      Company adopted Statement of Financial Accounting Standard No. 131, "Disclosures
      About Segments of an Enterprise and Related Information", ("SFAS No. 131").
      The
      Company operates in one reportable segment (see Note 1 for a brief description
      of the Company's business). The total revenues are attributed to geographic
      areas based on the location of end customers.




The
      following present total revenues for the years ended December 31, 2005, 2006
      and
      2007:




**Year ended December 31,****2007**
              
              **2006**
              
              **2005****(in thousands)**USA
              
              $
              23,392
              
              $
              15,048
              
              $
              17,423Europe
                  (other than Denmark)
              
              
              33,349
              
              
              28,449
              
              
              18,643Denmark
              
              
              15,750
              
              
              10,304
              
              
              12,334Israel
              
              
              7,820
              
              
              10,156
              
              
              7,991Other
              
              
              8,087
              
              
              4,047
              
              
              2,556$
              88,398
              
              $
              68,004
              
              $
              58,947





Sales
      by
      geographic areas are determined based on the customer’s location.




F-49




**BLUEPHOENIX
      SOLUTIONS LTD.**




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**Note** **13
        - Supplementary Financial Statement Information
        (Cont.):**




**B.**
            **Statements
                of Operations (cont.):**




**2.**
            **Principal
                Customers:**




Major
      customer over 10% of the Company’s revenues:




**2007**
            
            **2006**
            
            **2005**Customer
                A
            
            
            12
            %
            
            11
            %
            
            17
            %Customer
                B
            
            
            -
            
            
            15
            %
            
            -Customer
                C
            
            
            11
            %
            
            -
            
            
            -





**3.**
            **Restructuring
                Expenses:**




During
      the second and third quarter of fiscal year 2007, the Company implemented a
      restructuring plan which included reductions in workforce in all functions
      of
      the organization worldwide and closures of redundant facilities in order to
      reduce the Company’s cost structure. The Company followed SFAS 146 "Accounting
      for Costs Associated with Exit or Disposal Activities". A restructuring charge
      of $694 thousand was recorded during the year ended December 31, 2007,
      which was related to severance and benefits to terminated employees. All
      expenses, including adjustments, associated with the Company’s restructuring
      plans are included in “Restructuring” in the Consolidated Statements of
      Operations.





**4.**
            **Financial
                Expenses, Net:**




**Year
                ended December 31,****2007**
            
            **2006**
            
            **2005****(in
                thousands)**Interest
                income
            
            $
            437
            
            $
            237
            
            $
            191Foreign
                currency translation adjustments (see Note 1A4)
            
            
            (767
            )
            
            (50
            )
            
            (580
            )Interest
                expense
            
            
            (1,800
            )
            
            (1,117
            )
            
            (898
            )Debentures
                and convertible debt financial expenses
            
            
            (2,002
            )
            
            (2,981
            )
            
            (938
            )Income
                (loss) from derivative financial instruments and marketable
                securities
            
            
            (211
            )
            
            396
            
            
            247$
            (4,343
            )
            $
            (3,515
            )
            $
            (1,978
            )






F-50




**BLUEPHOENIX
      SOLUTIONS LTD.**




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**Note
      13 - Supplementary Financial Statement Information
      (Cont.):**




**B.**
            **Statements
                of Operations (cont.):**




**5.**
            **Other
                Income, Net:**


**Year ended December 31,****2007**
              
              **2006**
              
              **2005****(in thousands)**Gain
                  on sale of property and equipment
              
              $
              -
              
              $
              -
              
              $
              35Dividend
                  income (*)
              
              
              134
              
              
              282
              
              
              -Decrees
                  of provision for losses in formerly - consolidated
                subsidiary
                  (Note 2.I)
              
              
              300
              
              
              -
              
              
              -Shares
                  issued to the company by Cicero (Note 8)
              
              
              458
              
              
              -
              
              
              -Other
              
              
              -
              
              
              -
              
              
              69$
              892
              
              $
              282
              
              $
              104




(*) Dividend
      income from Steps Ventures, An Israeli venture capital investment group, in
      which the Company holds 375,000, shares representing 3.75% of their outstanding
      share capital.





**C.**
            **Earnings
                per Share:**




Basic
      earnings per share (“EPS”) was computed based on the average number of shares
      outstanding during each year. In computing diluted EPS, effect was given to
      share options outstanding in each period, using the treasury stock method,
      provided that such effect is not anti-dilutive.




The
      following table sets forth the computation of basic and diluted net earnings
      per
      share:




**Year ended December 31,****2007**
            
            **2006**
            
            **2005****(in thousands)****1.****Numerator:**Amount
                for basic earning (loss) per share - income toAvailable
                to shareholders
            
            $
            (8,196
            )
            $
            4,672
            
            $
            1,789Amount
                for diluted earnings (loss) per share - incomeavailable
                to shareholders
            
            $
            (8,196
            )
            $
            4,672
            
            $
            1,789**2.****Denominator:**Denominator
                for basic net earnings per share - weightedaverage
                of shares
            
            
            17,144,902
            
            
            13,889,483
            
            
            13,556,627Effect
                of dilutive securities:Employee
                share options
            
            
            -
            
            
            481,421
            
            
            403,382Denominator
                for diluted net earnings per share -weighted
                average shares and assumed exercise of options
            
            
            17,144,902
            
            
            14,370,904
            
            
            13,959,909Basic
                net earnings (loss) per share
            
            $
            (0.48
            )
            $
            0.34
            
            $
            0.13Diluted
                net earnings (loss) per share
            
            $
            (0.48
            )
            $
            0.33
            
            $
            0.13




F-51


**BLUEPHOENIX
      SOLUTIONS LTD.**




**NOTES
      TO CONSOLIDATED FINANCIAL STATEMENTS**





**Note
      13 - Supplementary Financial Statement Information
      (Cont.):**




**C.**
            **Earnings
                per Share (cont.):**




In
      2007,
      the Company incurred a net loss and therefore all share options and convertible
      debentures were potentially anti- dilutive.




Employees
      share options and warrants issued to purchase, 1,315,935 and 1,677,609 shares
      at
      various prices between $4.5 and $10.5 per share were outstanding during the
      years ended December 31, 2006 and 2005, respectively, but were not included
      in
      the computation of diluted EPS because the options’ exercise price was higher
      than the average market price of the ordinary shares. 715,649
      and 3,048,930 shares underlying the convertible debentures and notes were
      excluded from the computation of diluted EPS in 2006 and 2005 respectively,
      since their inclusion would have had an anti-dilutive effect on
      EPS.





**Note
      14 - Transactions with Related Parties:**




**Year ended December 31,****200**7
            
            **200**6
            
            **200**5**(in thousands)****A.**Selling,
                general and administrative expenses:management
                fees to Formula
            
            $
            45
            
            $
            180
            
            $
            180**B.**Revenues
                from sale of software conversion tool and software services to related
                parties related to Formula
            
            
            -
            
            $
            1,214
            
            $
            1,694**C.**Cost
                of revenues relating to services from related parties related to
                Formula
            
            
            -
            
            $
            1,217
            
            $
            1,761**D.**Reimbursement
                related to services rendered to affiliated and other companies related
                to
                Formula
            
            $
            117
            
            $
            43
            
            $
            41





**E** . In
      January 2006, the company entered into a services agreement with TIS Ltd.,
      ("TIS"), a Cyprus company. Under the agreement, TIS provided the Company with
      consulting and other professional services. When the Company signed the
      agreement with TIS, 38.8% of the share capital of TIS was held by CTI Ltd.,
      ("CTI"), a Cypriot company. Mr. Kilman, the Company’s chief executive officer
      and director holds 49% interest in CTI. Therefore, the transaction was
      considered as a related party transaction and the company obtained the necessary
      approvals required under Israeli law. In November 2006, Mr. Kilman notified
      the
      company that CTI sold the shares it held in TIS and it was no longer a
      shareholder of TIS. In 2006, the company paid fees to TIS in an aggregate amount
      of $300 thousand.




**F** . In
      connection with the sale by Formula of its controlling interest in BluePhoenix
      in June 2007, Formula paid a cash bonus of $1.8 million directly to Mr. Arie
      Kilman, the Company’s chief executive officer. The amount was included in the
      financial statements as a one-time non-cash expense under selling, general
      and
      administrative expenses with a corresponding credit to contributed (paid-up)
      capital, in accordance with SAB Topic 5T.




F-52




**BLUEPHOENIX
        SOLUTIONS LTD.**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**




**Note
      15 - Subsequent Events:**




**A.** In
      January 2008, the Company's board of directors decided to sell its holdings
      in
      Mainsoft, in which it holds a 58% controlling interest. This decision followed a
      strategic shift in Mainsoft's product development and marketing strategy outside
      of BluePhoenix's core business focus. For the period commencing January 1,
      2008
      and till MainSoft is sold, MainSoft’s results will be included in the Company’s
      financial statements as discontinued operation, in accordance with SFAS 144
      "Accounting for the Impairment or Disposal of Long-Lived Assets".





**B.** In
      January 2008, the Company entered into an agreement for the purchase of the
      entire outstanding share capital of TIS Consultants Ltd., or TIS, a company
      incorporated in Cyprus, that wholly owns a subsidiary incorporated in India,
      TISA Software Consultants Private Limited. Under the agreement, upon the closing
      of the transaction, the Company will pay the selling shareholders an aggregate
      amount of $500 thousand. In addition, the Company undertook to pay a contingent
      consideration equal to 5.5 times of the average operating profit of TIS in
      2008,
      2009 and 2010. In connection therewith, the Company will pay nonrefundable
      down
      payments in March 2009, March 2010 and March 2011, in each case based on the
      operating profit in the previous years. In addition, the Company undertook
      to
      pay an additional incremental consideration based on the growth in TIS revenues
      in the years 2008, 2009 and 2010 in an amount of up to 35% of the growth in
      TIS
      revenues in each of these years compared to TIS revenues in the previous year.
      30 days after the closing of the transaction, the Company will pay the selling
      shareholders $700 thousand as a nonrefundable advance payment on account of
      the
      contingent consideration. TIS provides consulting services, solutions and value
      added products to the banking industry, specializing in the market
      for Temenos GLOBUS/T24TM.




F-53